Unless you’re sitting on a lot of cash, you’ll probably need to borrow some money in order to finance the purchase of your first vacation rental property. Typically, it’s better to leverage other people’s money anyway when you’re investing. Why not hold onto your own cash reserves for the maintenance, insurance, vacancies, and taxes that you know you’ll have to cover?
Financing options are pretty similar for investors, whether you’re buying a long-term residential rental property or a short-term vacation rental. We’re going to talk about some conventional options and some not-so-conventional options. What we ask you to remember, however, is that your income and expenses are different with a vacation property than they are with a long-term rental. You’ll face more turnover and vacancy, and thus a bit less stability. Maintenance costs may be higher due to the wear and tear that multiple tenants during the course of a year can cause.
All of those things have to be part of your budget as you’re looking for the right loan.
Buying a vacation rental property in Florida is a worthy investment. Let’s take a look at how you should pay for it.
Conventional Loans and Vacation Rental Financing
A conventional loan is likely something you’re already familiar with. If you own a home yourself, you might have used this to buy it. The conventional loan comes from a bank, credit union, or other financial institution. It is a loan that’s based on your own financial risks, so lenders will be interested in documentation that demonstrates your assets, your cash in the bank, and your ability to manage credit and debt.
Why might you look at conventional loans when you’re buying your first vacation investment?
First of all, they’re well-regulated. Conventional loans also generally offer lower interest rates compared to other types of financing. This is especially important now, when interest rates are historically high. You’ll be paying more for your loan because of the more expensive mortgages, but the rate you receive is still likely to be lower than other types of loans. And, you’ll always have the opportunity to refinance once those interest rates begin to drop again.
A conventional loan also comes with flexible terms. These loans offer various terms, usually ranging from 15 to 30 years. You’ll have a fixed interest rate, unless you’re interested in a different rate option. This can provide payment stability over the long term.
If you decide you want to use a conventional loan in order to finance your first vacation rental investment, we recommend that you work with a strong broker who can find you the best deal. Or leverage your relationship with a local banker or lender. Asking for a home loan from a bank where you’re already doing business, for example, is a good start. They’ll know your financial history and you’ll feel like less of a credit risk to them. That will help you access more favorable terms.
Sounds like an obvious first choice, doesn’t it?
Not always and not for everyone.
For example, some borrowers struggle to meet the criteria that lenders have in place for these types of loans. You might find that conventional loans often require higher credit scores and lower debt-to-income ratios. There are also large down payments required, especially when you’re borrowing money to pay for a home that you’re not actually going to live in yourself. Typically, you’ll need to put down at least 20% of the property’s purchase price. The bank will be looking to see whether you have this money available before they approve you for a loan. Some lenders might even ask for 25% as a down payment.
Exploring the Potential of FHA Loans
Not every vacation rental property will be eligible for an FHA loan. In fact, you might find that very few of them actually are appropriate for this kind of funding. But, in some cases you will be able to leverage this unique government loan program in order to buy your first vacation rental.
FHA loans are attractive because they come with low down payments. You might only have to pay 3.5% in cash in order to take an FHA loan. This is a loan that comes from a bank or any other financial institution, just like a conventional mortgage. The difference is, this type of loan is insured by the federal government.
Borrowers like the lower down payment requirement. They also appreciate the fact that these loans are typically more lenient when it comes to credit scores and financial history.
Here’s the catch with an FHA loan: you’re only eligible to borrow under this program if the property is your primary residence. How can it be your primary residence when you’re planning to use it as a vacation rental?
Well, you can rent out rooms or certain parts of your property to vacationers and still qualify for the loan.
As we said, it’s not for everyone and it’s not for every property. You may have some trouble renting out a vacation home to tenants when you disclose that you actually live on the property. You likely won’t be able to charge as much. You may have more vacancy days than occupied days. Think carefully about this option before moving forward. Talk to a local property manager and your lender or broker.
Another planning point when we’re talking about FHA loans: you’ll likely have to pay mortgage insurance premiums, too. This is due to the fact that your down payment was so low. The mortgage insurance is required and will add to your monthly costs.
VA Loans for Veterans Interested in Real Estate Investing
Another loan that won’t work for everyone but might work for you is the VA loan, which is guaranteed by the Veterans Administration. To be eligible, you must be a veteran, active-duty service member, and possibly a member of the National Guard and Reserves. Like the FHA loan, there is a primary residence requirement. You’ll have to do some fancy footwork to rent out part of the home you’re living in to tourists and vacationers.
What people like about this loan is that there’s no down payment required at all. VA loans Offer 100% financing for eligible veterans and active-duty military members. There’s no private mortgage insurance (PMI) required, either, reducing overall costs.
Let’s Explore Portfolio Loans
What are we talking about when we talk about portfolio loans? This type of loan stays with the initial lender as part of their portfolio. This may not sound atypical, but generally, your loan will be sold on the secondary market almost as soon as it closes. A portfolio loan does not get sold. These are offered by individual lenders who can set their terms, providing more flexibility. They can be an attractive option when you’re looking for faster, easier approval. These loans are often easier to obtain for investors with less-than-perfect credit.
What you do have to expect with portfolio loans is a higher interest rate. Compared to conventional loans, you’ll be paying more in interest. There are also shorter terms, which means paying back your portfolio loan will be more of a priority. These shorter repayment terms can increase monthly payments.
Hard Money Loans and Your Rental Plans
What about a hard money loan?
It’s a good way to access the money you need quickly. They can be approved and funded much faster than conventional loans. There’s also more flexibility with the criteria to obtain funds. Your lender will focus more on your potential property’s value than on your financial security or credit standing.
However, there are higher costs associated with hard money loans. You can expect to pay higher interest rates. They’re also meant to be short term loans only. At the end of the loan term, which is typically one to three years, you’ll have to sell your asset or refinance into another type of loan. You’ll have to decide if you can work with this sense of urgency.
Home Equity Loans and HELOCs
People use the equity in their own homes to finance a number of ventures, from college tuition to world travel to additional real estate acquisitions. You can use a home equity loan or a home equity line of credit (HELOC) to buy a vacation property. Here’s what you need to know:
- You’re Utilizing Existing Equity. If you already own property with substantial equity, you can tap into that for your investment.
- Lower Interest Rates are Available. These options typically offer lower interest rates compared to hard money loans.
- Collateral is Required and It’s Your Home. Your home serves as collateral, putting it at risk if you default.
- Variable Rates. HELOCs often come with variable interest rates, leading to fluctuating monthly payments.
Choosing the right financing option is a big first step when you’re getting ready to invest in a vacation rental property for the first time.
Make sure you’re surrounding yourself with experts. It’s the best way to avoid risk and to set yourself up for immediate success.
We’d be happy to help. Our experience in the vacation rental market and with connecting buyers with loans can help you leverage the best available products and terms. Please contact us at Anchor Down Real Estate & Rentals
