I think it’s safe to say that the most of you have, at some point in the past few years, pondered the question, “How can I join the other investors who are reaping the benefits of short-term rentals (STRs)?” “How the heck does anyone finance one of these?” is a question I’m willing to wager the majority of you have asked if you’ve gone the extra mile and sought out a loan on a STR.

I want to share some thoughts with you on how to set yourself up for success when you grow your portfolio of short-term rentals (STRs). I am an active STR investor and the partner and chief operating officer of a national non-qualified mortgage lender that specializes in investment property loans. Calls from investors who were left out in the cold days leading up to closure because their lender misunderstood the investment strategy or the complexities of their loan program are constant and frustrating.

I felt obligated to equip my fellow BiggerPockets readers with the necessary knowledge to properly navigate this arena. You may enhance your investing toolbox with a true Swiss Army knife by learning about the various loan products and how to ask the proper questions of a lender.

How Much Longer Will Short-Term Rentals Bring in Money?

The current statistics have me feeling confident and yelling out a cheer! Even though inflation is running at a record high, the market for short-term rentals (STRs) in the United States has been consistently strong, and signs suggest that demand will continue to outstrip demand from previous years. According to AirDNA’s forecast study, there has been no noticeable reduction in the amount of bookings, even if inflation has started to impact consumer purchasing.

This is fantastic news for investors who already own STRs and are looking to expand to their portfolio with more properties that bring in a lot of money quickly rather than relying on long-term rental revenue.

A Comprehensive Guide to Financing Vacation Rentals
Do traditional loans exist?

With numerous exceptions, the answer is yes. Friendly to investors? By a wide margin!
Fannie Mae and Freddie Mac conventional loans are quite stringent and prioritize the borrower’s personal income over the property’s short-term rental income. Because only 75% of the property’s long-term rent is added to the income element of the debt-to-income (DTI) ratio calculation, it is punitive towards STRs.

It is possible to get a conventional loan on a STR if your W-2 and taxable income are really high (meaning you aren’t deducting your income) and if you’re ready to put in a lot of work.

Would you like to purchase a piece of real estate in an LLC, amass more than ten single-family residences, or join a select group of wealthy property owners? Completely forbidden! Conventional lenders are required to adhere to these 1,243-page loan criteria. Wow, there are so many rules!

Are there alternative methods of financing?

Of course! The most common and convenient method of financing a STR is through a loan based on the Debt Service Coverage Ratio (DSCR) for investment properties. Because the loan amount is based on the property’s STR revenue rather than the borrower’s personal income, this kind of loan is quite advantageous for investors. As a result, STR portfolio scalability is possible without impacting the DTI ratio.

A short-term bridge loan that pays interest only is another viable choice that might be considered right away. Borrowers should expect to pay back between seventy-five and eighty percent of the home’s purchase price over the course of 18 to 24 months. Since there is no prepayment penalty and no DTI or DSCR criteria with a bridge loan, it is extremely easy and flexible to buy a short-term rental.

Because of this, you can always refinance if interest rates go down. You can close faster with a bridge loan, extend the expiry date of long-term tenant leases, renovate and equip the property to increase future income, and establish STR rental history. In order to extend their STR portfolio, many wealthy investors employ this bridge to long-term funding.

Can you tell me how to figure out the debt service coverage ratio?

Total property income divided by all expenses (principal, interest, taxes, insurance, and HOA dues, if any) is the discounted sales price ratio (DSCR). To determine the income, we look at the property’s STR income, which is the income earned by renting out the space during the past twelve months.

A DSCR greater than 1.10 indicates that the property will generate positive cash flow, which is a requirement for the loan. The maximum leverage that these loans permit is 80% for a buy or rate/term refinance and 75% for a cash-out refinance. This is because the loan examines short-term rental revenue instead of long-term rental income, greatly increasing the likelihood that you will be able to qualify.

What if there isn’t a 12-month record of short-term rentals for this property?
Sure thing! There is a lender out there that deals with investors in short-term rentals; they have probably dealt with situations like this before. When people buy a home, they often turn it into a short-term rental instead of living in it or renting it out for an extended period of time. Here, rather than using the long-term rent that an appraiser includes in their report, DSCR can be calculated using the possible short-term rental revenue, which is 80-90% of the AirDNA STR Rent Estimate – “Rentalizer” according to some lenders.

Lenders in this situation often favor borrowers who have either prior expertise managing STR properties (preferably in the market at hand) or who have a contract with a reputable STR property management business (e.g., Evolve, AvantStay, Vacasa, etc.).

An illustration of this in action may be seen here:

Suppose you’re planning to purchase an empty home that, when rented out to long-term tenants, would bring in $3,000 per month, but would average $7,000 per month when rented out to short-term tenants.
Consider a $625,000 purchase price and an interest rate of 6.75 percent; you would like a loan of $500,000 with 80% LTC. Principal, interest, taxes, insurance, and HOA fees add up to about $3,200 each month, for a total of $4,000 in PITIA.
With only $3,000 in rental revenue, you would only have a 0.75 DSCR (3K/4K), which is not enough to qualify for the 80% loan. To get a 1.0 DSCR, you will have to lower the loan amount to around $375,000 (which is 60% of the loan amount). An extra $125,000 would be needed for closing…that’s a lot!
The 80% LTC loan should be easily accessible if your lender permits DSCR eligibility based on 90% of your projected short-term rental income. With a monthly income of $6,300 (the result of dividing 90% of $7,000 by $4,000 in expenses), you have a DSCR of 1.575. You are exquisite!

Could it be that the property need renovations prior to being advertised as a short-term rental?

Obtaining a private or hard-money bridging loan to pay the purchase price and renovation charges is one of your possibilities, but it’s also the easiest. For a rate/term refinance to be put up instead of a cash-out refinance—which usually has higher interest rates and a lower maximum loan-to-value—it is ideal for this loan to end up being 75-80% of the after-repair value.