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So, you’re taking the plunge and buying your dream vacation property. You and your family will love it, and you plan to rent it out to help cover expenses. Or, maybe you already own a vacation rental and have done so well on short-term rentals (STRs) that you are interested in buying one, two or even many more. What are your financing options?
Your financing options fall into three main buckets: conventional, portfolio and alternative. We’ll start with the simplest case.
If you are buying your first vacation property, you probably should 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 cash reserves (the amount depends on your credit score and down payment), and 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 home. So you’ll need to meet the gross monthly income requirement without any rent credit. Plan on 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.
Portfolio and Alternative Mortgage Solutions
But what if you are self-employed, or maybe asset-rich but with little taxable monthly income, or maybe you already own a number of rental homes? In these situations, you should skip conventional and go straight to evaluating portfolio and alternative mortgage solutions. Portfolio is just a fancy way of saying, “community bank.” If you have good credit and have an ongoing relationship with a local bank, then you should talk to them to see if they might finance your new home purchase
Typically, these loans will be a bit more expensive in terms of fees and rate than a conventional loan. Also, they usually will amortize over 15 or 20 years rather than 30 years, and include a “balloon” payment after five years. But 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 mortgage lenders typically offer a faster, smoother process with more approval flexibility, but at higher costs.
STRs, including vacation rentals, are an exciting and rapidly growing new asset class. Airbnb and HomeAway, among others, are raising awareness of this exciting new opportunity. Others are building next-generation property management tools and companies to help owners efficiently manage their STRs.
For example, Rented.com adds an interesting twist by enabling property owners to solicit competitive bids from property management companies, including bids that guarantee monthly rental cash flow to the owner. Using sites like Rented.com can help you plan your STR strategy even better.