The Basics of Financing a Short-Term Rental

Hey there! Are you thinking about getting started with investing in short-term rentals? You’ve come to the right place. Investing in real estate can be a smart way to build your long-term wealth and achieve financial freedom, but it can also be overwhelming if you’re new to the game. Before you can start earning income from your property, you need to figure out how to finance it. In this blog post, we’ll discuss the basics of financing a short-term rental property.

Before you start looking for a property, it’s important to determine your budget. This will help you narrow down your options and ensure that you’re not overspending. You should consider your current income, any savings you have, and how much you’re willing to borrow. Additionally, you should factor in the cost of the property, any renovations that need to be made, and any fees associated with owning a rental property. These additional costs can be more significant than you think, depending on the work needed, so it is important to take these into consideration before you finalize your purchase.

2. Research Financing Options: Traditional & DSCR

The most common financing option for STRs is the traditional loan where lenders consider two factors: the borrower’s credibility and income. A traditional loan is straightforward and offers competitive interest rates. However, these loans have more restrictive lending requirements and are the least scalable, so it’s important to consider what your goals are. Furthermore, these loans are based on your Debt-to-Income ratio which typically need a ratio of at least 50% to qualify. Lower ratios, meaning less cash flow, might make it more challenging to secure a loan.

If a traditional loan isn’t the route you want to take, an asset-based loan might be for you. These differ from traditional loans because they assess the actual or projected income of a given property rather than the DTI ratio. Lenders calculate the Debt Service Coverage Ratio (DSCR) by dividing the property income by the principal, interest, taxes, insurance, and HOA fees. The higher the DSCR ratio, the more net operating income is available to repay the debt. 

This type of loan offers buyers a significant advantage since borrowing power is determined by existing assets rather than by personal recurring income. Further, the option is advantageous for entrepreneurial investors looking to scale their portfolio, as you can continue using cash-flowing properties and equity to increase leverage across multiple purchases.

Most DSCR loans are based on existing cash-flowing properties. However, some of our lending partners also offer loans based on the projected cash flow of purchase. These are calculated by taking a sourcing tool like Keyturn's to estimate the expected income of a potential purchase and use 80-90% of that income to qualify the loan. To learn more, talk to a member of our team today!

With all of these options, it’s important to compare loan requirements, interest rates, repayment terms, and any other associated fees to determine which one is the best fit for your situation.

Most lenders require a down payment when financing a rental property. The amount of the down payment will depend on the lender and your financial situation, so it’s important to factor in the down payment when determining your budget. Traditional loans typically require a 20% down payment to stay competitive in today’s market versus a DSCR loan where you’ll typically want to have a ratio of around 1.0, meaning your rental income is greater than your debt. Some lenders may offer even more competitive rates, going as low as 0.75. Which one you choose depends on your financial circumstances and flexibility with interest rates and repayment terms.

In addition to the cost of the property and any financing fees, there are other costs associated with owning a rental property. You’ll need to budget for maintenance and repairs, property management fees, and insurance. It’s important to factor these costs into your budget to ensure you’re making a profitable investment. Make sure to also consider broker fees for your purchase!

Financing a short-term rental property can seem overwhelming, but with careful planning and research, it can be a rewarding investment opportunity. By determining your budget, researching financing options, and considering other costs, you can make an informed decision and start earning income from your rental property.

With Keyturn’s sourcing engine, users are able to access listings from 50+ top booking sites, sorted by those that fit within the individual’s financial circumstances. In addition, you can plug in all your expenses, incomes, etc. for automatic custom underwriting as you search - so there are no surprises once you buy! Learn more about Keyturn’s sourcing engine here.