View all articles
Short-term vacation rentals are a great way to boost your income and with regular bookings, a holiday property can even outperform a standard rental property.
When carefully considered, a rental that’s located in the right place and offers accessible transport links is a convenient property for tourists and holidaymakers.
But how do you finance this investment dream? When you’re securing a loan for a second property, the criteria can differ from your main residence – consider this your guide to the different financing options for your holiday rental.
Plan Your Investment Objectives
First of all, you need to define your investment goals:
- Why are you looking to invest in a holiday rental?
- What do you want to invest in, and where?
There’s no right answer, but you need to know what you’re hoping to achieve with a short-term rental before you begin, as you may end up choosing the wrong property, in the wrong location, and derailing your progress entirely from the start.
For example, some investors may choose a short-term rental in an area they enjoy visiting themselves because they want to be able to use it for personal use as well as for profit. In these instances, the goal of a significant income isn’t really a priority. Rather the objective is to offset the mortgage with income.
Know the Market
Real estate is a broad sector so do your due diligence. You need to know what you’re getting into and understand key market trends in order to make a solid investment decision and choose the best method of financing.
The type of property or the cost could influence the method of financing – for example, it may not suit conventional lending – so having an in-depth knowledge of the market is critical.
Do you know the key metrics (more on this later) or the cost of homes in the area you want to buy in? Do you know how seasonality will affect your income?
Do Your Research Into Lenders
If you qualify, a conventional loan can be one of the most affordable ways to finance a second property. Banks and mortgage lenders often offer the best rates, but they also have strict lending requirements, so to get approved, you may need to meet stricter criteria than you did with your first property.
Pete Mugleston, Mortgage Broker and MD at Online Mortgage Advisor, highlights the complexities between different mortgage lenders and how different they assess eligibility. “Established landlords are generally more likely to pass a lender’s buy-to-let mortgage eligibility checks than a first-time buyer, but some providers are wary of borrowers with large portfolios and draw the line at four buy-to-let mortgages. These customers would be classed as portfolio landlords. A few, however, have no buy-to-let limits in this regard”.
A conventional loan is best suited to low-risk borrowers where the primary residence isn’t used as collateral, but the strict lending requirements can be challenging and vary from country to country, so doing your research thoroughly before beginning your venture is critical.
Consider the Alternatives
A traditional loan may be a practical option but it’s not the only way to finance a holiday property, nor is it necessarily the best for your situation.
An asset-based loan, for example, is evaluated based on the potential income of the property rather than the borrower’s income. To calculate this, lenders look at the income of the property and the Debt Service Coverage Ratio (DSCR) which is the property’s income divided by the principal, interest, taxes, insurance and any HOA fees.
Asset-based loans are beneficial to the investor because the borrowing power isn’t dependent on their individual income, so they can scale their property portfolio and add more properties simply by providing evidence that they are cash-flowing and that there’s equity for the down payments. However, the downside to this type of loan is that there can be restrictions on the type of property and location, and down payments can be higher than a traditional loan.
Home Equity Line of Credit and Cash-Out Refinance loans are other options which require financing on the existing primary home or another investment property. In these instances, the investor can tap into equity they’ve built on another property and use that to acquire a new short-term rental property.
Know Your Metrics
Understanding key metrics can help you when you’re considering a short-term rental, and it can also be a deciding factor in being approved for borrowing if you’re choosing a route that requires evidence of the potential income.
One of the most important metrics for securing a mortgage is, naturally, the rental income you can expect to earn per month or annually. It’s the most relevant metric for calculating the ROI of a property.
But you also should know the occupancy rate which is the percentage of available nights a short-term rental is booked per month. The higher the occupancy rate, the higher your profits.
One of the most important factors when it comes to securing finance for a short-term rental is the FICO score. This credit score informs lenders of your creditworthiness and the likelihood of you paying back the loan, based on your history of paying back credit.
Another metric to keep on top of is the debt-to-income ratio which is calculated by dividing the borrower’s monthly debt payments by their gross income per month. It determines the level of risk for a lender and how well you’re likely to be able to manage your debt repayments.
Final Thoughts
Investing in a short-term rental might seem complex at first, but there are plenty of options when it comes to financing your new venture. Provided you have identified your investment goals, understand the market and have carried out thorough research into the different options available to you, so you can choose the best one for your circumstances, you can invest with confidence.
For a powerful landlord software that will save you time, keep you compliant and organised take a look at our all-in-one property management software.
