Short-Term Rental Property Financing

This blog post has been updated May 2024 for freshness and accuracy

There’s a lot of appeal to investing in a vacation rental property. Not only does it provide a great spot for you and your family to travel, but it’s also an opportunity to diversify your investment portfolio and build wealth over time. Perhaps you’re looking into purchasing your first rental, or maybe you’re toying with the idea of investing in even more locations. Regardless, before diving into this quickly growing market you’ll benefit from exploring some of the nuances, considerations, and strategies.

What is a short-term rental property?

Short-term rental properties are any residential home unit or outlying building rented out for a short period, ranging anywhere from one night to several weeks. This would include a Vrbo or Airbnb property, as well as those that are advertised by individual proprietors. It may be a primary home that you rent out on a short-term basis to visitors, or a dedicated vacation home used solely as an investment. 

You may rent out only one room or an entire residential building of any size, from a small cabin to a grand, multistory retreat. It can also include condominiums and townhomes from which you collect short-term rental income. 

What is short-term rental financing?

Short-term rental financing is financing that assists you in affording the purchase of real estate investment property intended as a vacation property. As with other mortgage options, the short-term rental lender provides the upfront funds, with you paying a down payment and closing costs, and then you repay them the original sum with interest through monthly mortgage installments.

Short-Term Rental Financing Options

Your financing options for investment property loans fall into three main buckets: conventional, portfolio, debt–service coverage ratio, and vacation rental loans. We'll start with the simplest case.

Conventional Mortgages

If you’re buying your first vacation property, you should probably start by looking at a conventional mortgage (Quicken, Wells Fargo, Chase, etc.) similar to the loan you have on your primary residence. 

To qualify, you'll need to put 10–20% down, have two to 12 months of cash reserves (the amount depends on your credit score and down payment). At the same time, your monthly combined mortgage payments on your primary residence and second home (including taxes, insurance, and any HOA dues) cannot exceed 45% of your gross monthly income.

In meeting this requirement, the lender will assume you won't generate any income from renting your new property. So, you'll need to meet the gross monthly income requirement without any rent credit. Expect 60–120 days to close. Also, plan on providing your full tax returns, a lot of income and asset verification documentation, and a variety of letters of explanation.

Conventional loans have lower interest rates than other options. However, they are the hardest to qualify for.

Portfolio Mortgage Solutions

But what if you are self-employed, or maybe asset-rich but with little taxable monthly income, or perhaps you already own multiple rental homes? In these situations, you should skip conventional loans and go straight to evaluating portfolio and alternative loan programs.

"Portfolio" is just a fancy way of saying "community bank." If you have good credit and an ongoing relationship with a local bank, talk to them to see if they might finance your new home purchase.
Typically, these loans will be a bit more expensive. They'll have higher interest rates and additional fees that a conventional loan may not include. Also, they usually amortize over 15 or 20 years rather than 30 years and include a "balloon" payment after five or ten years.

However, your local community bank will hold this loan in their loan portfolio (hence the name), so they can be a bit more flexible than a conventional lender. Again, plan on a lot of documentation and 60-120 days to close.

Alternative Lenders

Alternative lenders are private lenders offering more expensive, but also more flexible options, as they often specialize in higher-risk properties such as investment properties. The most important loan types offered by Visio are DSCR and short-term rental loans that are made for investors.

DSCR Loans

How a DSCR loan works is that it divides the monthly rental income by the debt-service (principal, interest, taxes, insurance, and association dues). The ratio shows the profitability of the rental property after it services its monthly debts. The bigger the ratio, the more profitable the property.

While debt-service coverage loans have higher interest rates and down payment requirements compared to conventional loans, you can roll more properties into the home loan than you could with other loan options. 

This makes the DSCR a suitable short-term rental loan for investors interested in multiple rental properties, or investors whose primary source of income comes from other real estate properties. 

They are also an excellent option for self-employed borrowers whose source of income doesn't qualify them for a conventional loan. Finally, you can protect your personal assets by applying as an LLC.

Specialized Vacation Rental Loans

Alternative private lenders also offer loan programs designed for a specific type of property. If you have built home equity through investing in a residence or another rental property, you can refinance the loan, apply for a specialized vacation rental loan, and then purchase another property for short-term rentals. 

Visio's vacation rental loans are made for short-term rentals and people who want to hold them for a longer period of time. They have 30-year loan terms, fast closing time so you don't miss out on a hot property, and straightforward cash-flow-focused requirements.

Fast and Dependable Vacation Rental Loans from Visio

When to Invest in Short-Term Rentals

The vacation rental property market is directly tied to the overall economy. When people are traveling, cash flow will be high, but when the economy takes a hit, tourism will be one of the first things to fall. As such, you need to take stock of the overall tourism market, both in general and in your local market, to decide what kind of investment makes the most sense for you at this time.

62% of Americans stated that they intended to travel more in 2023, and the numbers support this. The travel industry grew by 4.4% last year, with California alone experiencing an 8% increase in tourists. The market has reached about 80% of its pre-pandemic levels, and it's expected to rebound further in 2024.

It's clear that this is a good time to invest in vacation homes overall, but you also need to choose your timing carefully. When do you believe you can have the property ready? Will it be available for seasonal demand in your area? Answering these questions means understanding the typical peak seasons in the area of interest and planning accordingly so that you're ready for the season. 

Lastly, you must also consider general market conditions, such as current interest rates, so that you can get the best possible terms for your vacation rental loan. 

Are You Ready to Invest in Short-Term Rentals?

The short-term rental industry is clearly booming, yet before diving in it is important to evaluate this strategy from different angles. Consider consulting your financial and other advisors for personalized advice.

Making Sure You are Financially Ready

Many new real estate investors do not realize that a larger down payment is needed for investment properties than for owner-occupied homes. With consumer mortgages, you often can put down as little as 3%, yet with investment properties, you will likely need at least 20% of the purchase price.

You also are going to need to make sure you have enough money to fully stock your vacation rental property with furniture and amenities, in addition to any closing costs, insurance, vacancy expenses, and, of course, your down payment.

Pros & Cons of Vacation Rentals as an Investment Strategy

Pros

Here are the main pros of investing in STRs:

Highly Lucrative: You may be able to generate higher returns with vacation rentals than with long-term rentals. Typically, you will generate more rental revenue with a well-performing short-term rental. These higher revenues usually are partially offset by higher operating expenses.

High Demand and Marketing Potential: With the amount of vacation rental listing sites available, not only is it easy to market your property to potential vacationers, but there is also a growing amount of demand for vacation rentals.

High Appreciation Potential: Higher-priced properties in desirable locations tend to appreciate more than your run-of-the-mill long-term rental property.

Personal Use: Owners can use the property for a limited number of days each year without losing their tax benefits.

Cons

At the same time, there are some downsides to this investment strategy:

Regulations: Many cities and homeowner associations have regulations and even bans on short-term rentals. That’s why it is extremely important to check the requirements in your area before purchasing a vacation rental. Some cities, however, such as beach towns, are very supportive of short-term rentals. It’s always a good idea to confirm.

Off-Season: Vacation rentals tend to be seasonal. For example, summer is a great time to go to the beach, but November is not as big of a draw. Lodgify has great tips to increase off-season bookings.

Management: When you have guests checking in and out every three days, your short-term rentals need cleaning every three days. You also must get new guests their keys and collect keys from departing guests. It can be a lot of work and particularly challenging if you live in another city. That’s why a good property management platform or company can be a game-changer.

Volatility: Consumer spending on travel and leisure is subject to changing economic conditions. Often during recessions, consumers spend less on travel and leisure. Plan accordingly to be able to handle an increase in vacancy in the event of an economic slowdown.

If you have fully evaluated the STR investment strategy and would like to move forward, here is our guide to finding, financing, and maintaining vacation rentals backed by our decades of experience and industry expertise.

What Makes Financing Vacation Rentals Different

Investors typically turn to alternative lenders like Visio Lending for a few reasons. The first situation is if they are self-employed, including owning their own business. Another reason would be that they already own too many properties to qualify for another conventional mortgage.

Finally, and importantly, they may turn to an alternative lender because they want to own their investment properties in a legal entity to protect their other assets. That is not allowed with conventional mortgages. We'll cover some of the key nuances of financing an STR below.

Residential Properties Need Residential Appraisals

Traditionally, for rental properties, appraisers fill out a 1007 report on comparable rents for long-term leases-- think a year or more. Appraisers primarily appraise homes for owner-occupiers. Every once in a while they are asked to appraise a home as a long-term rental.

So, in most markets, they rarely are hired to appraise an STR or vacation rental. Getting an accurate appraisal of an STR or vacation rental’s potential gross rents, therefore, can be difficult because most appraisers are unsure how to determine short-term rents.

As an alternative lender, Visio is able to use a common-sense approach to determining STR rents. Visio considers any actual rent performance available on the property and then augments that information with comparable data from a variety of data sources. Unlike a licensed appraiser, Visio is not limited in the information it can use to establish an appropriate rent estimate.

Turnover Costs

Let’s say you generate $3,000 per month on an STR and only $2,000 a month on a long-term lease for the same property. While it might look like the STR is far more lucrative, in reality, the turnover and maintenance costs associated with an STR are higher so you need to make some adjustments before drawing a conclusion.

At Visio, we adjust our models for STRs by adjusting the gross rents used in our underwriting calculations to normalize them against long-term rentals. Our goal is to do as much as we can to STRs to make comparing them to long-term rentals apples to apples, instead of apples and oranges.

Regulatory Risks

Owning a vacation rental in Orlando by Disney World is a different ballgame than owning one in the heart of an elite neighborhood in Boston.

While a large part of Orlando’s economy relies on tourists, in a more suburban neighborhood, the city might not be as open to short-term renters and might pass regulations restricting them. This can be tricky for a lender, particularly in cases where the owner designed or modified the house to accommodate guests.

A nine-bed, nine-bath house might be fantastic for vacationers, but not for many long-term renters. So, what happens if the short-term use becomes outlawed? This is an issue any lender needs to consider when underwriting a loan.

Visio Lending’s Leading Vacation Rental Loan Program

Recognizing the nuances associated with financing short-term rentals, Visio Lending spearheaded a program that is underwritten based on vacation rental income rather than an investor’s income and assets. Here is why our vacation rental product is the best on the market:

• We offer common sense underwriting of your short-term rentals.
• Our loans are full, 30-year terms with no balloons.
• We are a low documentation lender and do not require tax returns or personal income statements.
• We lend to corporate entities, so investors can protect their identity and assets.
• Our pricing is simple and haggle-free.

Related: Guide to SFR Real Estate & Types of Loans