The Perfect Financing for Short-Term Rental Properties

Buying a residential investment property can deliver two enormous benefits: personal use and an income stream. You can enjoy a vacation home when you wish and earn money by renting it the rest of the time. Financing for a vacation home is made simple with loan programs such as a DSCR loan. Let’s look at how you might use this versatile financial tool to expand your investment portfolio.

The Basics of DSCR

Mortgage professionals often use a debt-service coverage ratio DSCR to determine if the potential borrower’s cash flow can service debt obligations. DSCR measures how the cash (or potential cash) investment generates income compared to debt costs, including a loan’s interest, principal, and related expenses.

To Calculate the DSCR, you divide net operating income (NOI) by the debt service amount. In real estate, NOI is the before-tax revenue a property generates, minus operating expenses. Total debt service is the sum a borrower must put toward debt repayment.

What is a DSCR Loan?

DSCR loans are often the go-to choice for real estate investors looking for financing. As these investors often write off property expenses, their tax returns may not be well-suited to qualify for conventional loans. Hence the need for DSCRs.

DSCR mortgages are non-QM loans that usually use the income a property generates instead of personal finances for qualification. Unlike traditional mortgage loans, DSCRs usually don’t require income verification, the borrower’s debt-to-income (DTI) ratio, or tax returns. As DSCR loans generally don’t hinge on personal factors, a borrower with less-than-perfect credit may still qualify.

How Does a DSCR Loan Work?

This mortgage loan is for residential income-generating properties, not primary residences. While the owner can stay at a property that’s purchased with a DSCR loan, one can’t live there.

There’s usually no property limit; unlike conventional mortgages, DSCRs often have no set number of properties that can be financed. Or limitations on the property type. You could feasibly use a DSCR to finance a single-family home, a multi-family property, a condo, a duplex, a triplex, and more.

Key Benefits of a DSCR Loan

When you purchase a short-term rental property with a DSCR loan, you may not have to provide any personal income documentation. This can make it easier for new investors to get financing. Because a mortgage professional’s chief priority is verifying a property’s financial viability rather than the borrower, DSCRs can have faster closing times compared to traditional mortgages.

Some short-term rental investors choose to close in the name of a limited liability company (LLC), keeping their personal finances separate from their business dealings. And DSCR programs often include cash-out refinancing options.

How to Finance a Vacation Home Using a STR Loan Program

A Look at the Short-Term Rental Market

Are rental platforms such as Airbnb and Vrbo a fad that’s peaked? Not according to market research. Last year, the U.S. short-term rental market had a value of nearly $30 billion, and it’s expected to top $80 billion over the next ten years. Ever-increasing corporate travel, personal travel, and staycations are driving the rise, led by Gen Z and Millennials who prefer the short-term accommodation experience over hotels.

What types of short-term rentals do these people want the most? Entire homes are the most popular, offering the most consistent occupancy rate among types of short-term rentals.

DSCR Loan Requirements

What number should you look for? A DSCR of 1 indicates that the revenue a property generates can cover the loan obligations. Often, mortgage professionals may wish to see a DSCR of up to 1.25 or higher for loan approval. What does that look like? For example, if a property has a monthly NOI of $5,000 and the debt service is $2,750, the DSCR is approximately 1.82.

The approval process usually includes a market rent survey. Here, an appraiser will determine if the property can generate enough income to cover the mortgage payment. Appraisers may consider factors such as average rent for the market area, rental demand, seasonality, and long-term trends. The survey usually includes an on-site visit to assess the property’s physical condition, amenities, and features.

Top Features in Short-Term Rental Properties

Simply buying a home and listing it on a rental platform is no sure recipe for success. Consider what features short-term renters want most:

  • Local attractions. Is the home near a beach, a mountain, or a popular park? Perhaps it’s close to a theme park or the stroll-friendly streets of a downtown district. Travelers like dynamic destinations.

 

  • Near nature. Escapes to rural areas are hugely popular among short-term renters. A home surrounded by nature, such as a wooded area, is likely to attract more bookings.

 

  • A touch of luxury. A pool. A spa tub. Outdoor living space. Homes with amenities that go beyond the basics are usually in higher demand.

 

  • Privacy. Most folks don’t want to deal with strangers on their getaways. So watch out for homes with spaces such as shared entrances and communal outdoor areas.

Applying for a DSCR Loan on a Short-Term Rental Property…

Your mortgage professional may wish to see a credit score of 680 or higher. At a minimum, the short-term rental’s DSCR should be 1 (above the profitability line). The higher the DSCR, the better; the more money a property generates relative to the loan amount, the less risk a mortgage professional takes on.

It’s common for DSCR loans to require a 20% or a 25% down payment, and that could go up to 30% if the borrower is a first-timer with short-term rentals. You may have to show a certain amount of liquid assets, such as a savings account or a money market account, to get approved.

Some mortgage professionals may wish to see a strong rental history for the property; a vacancy rate of 10% or less is ideal. Showing a rental property’s worth often involves documentation. So you’ll want to assemble records such as property tax statements, maintenance records, rental history, and more.

Buying an investment property isn’t something only other people do. Talk to one of our mortgage professionals about how you can enter the short-term rental market with a DSCR loan.

To learn more about short term rental loans and to speak with a loan specialist, contact us today.