Vacation Rental Loans [DSCR]

DSCR Loan for Vacation Rental

A DSCR loan is a business loan for vacation rental property investing. These are business purpose rental loans for LLC investors. They are used to refinance or purchase a new vacation rental property, helping to grow a vacation rental business.

Potential Monthly Income

DSCR loans focus on the property value and potential monthly cash flow rather than relying on the borrower’s personal income or credit history.

Asset Based Loan Eligibility

Unlike FHA loans, DSCR loan eligibility is based on the investment property ability to generate income that is sufficient enough to cover monthly debt payments before you have to resort to your life savings.

DSCR Ratio

Private lenders calculate the DSCR ratio to see if the short term rental property is capable of generating enough revenue to support the monthly loan payments. The higher the DSCR, the more likely the property’s income can cover the debt, reducing the likelihood of financial losses for the lender.

Rental Portfolio Growth

DSCR loans give real estate investors the ability to finance multiple vacation rental home properties at once. Therefore, an investor can grow their rental portfolio by looking for properties with high income-generating potential.

Vacation Rental Refinancing

As vacation rental properties improve their cash flow, investors may refinance to reduce borrowing costs and increase potential returns. This is great if refinancing to lower monthly mortgage payments, refinancing a bridge loan with high interest rates or if interest rates are lowered.

Cash Out Refinance a Vacation Rental

Cash out refinance rental loans can be used to purchase more vacation rentals. Cash out refinancing allows you to raise cash that is needed for a down payment on a new investment property.

Vacation Rental Loan Process

1. Borrower fills out a loan application with the property details, potential or current rental income and estimated credit score.
2. Lender requests borrower authorization forms to pull credit and order an appraisal.
3. Lender requests LLC documents such as Articles of Organization docs, Operating Agreement and EIN.
4. Lender calculates the potential monthly rental income. Taking into account the location, property type, local rental market rates and market demand trends.
5. The lender evaluates the property’s operating expenses, such as property taxes, insurance, property management fees (if any), maintenance costs, and utilities.
6. The lender calculates the Debt Service Coverage Ratio (DSCR) by dividing the property’s net operating income (NOI) by the total debt service (loan payment).
7. Many lenders look for a DSCR of at least 1.2, while others require a minimum 1.5 debt to income ratio. A higher DSCR ensures loan repayment, since the income is at least 20-50% higher than monthly debt payments.
8. If the vacation rental DSCR meets the lender’s loan criteria, the loan is approved.
9. The title agency and funder work together to close the loan.
10. The borrower proceeds to purchase or refinance a vacation rental which can now be used as a short term rental on AirBNB or VRBO.

Tips for Financing Vacation Rentals

1. Refinance personal debt and credit cards to increase your credit score before applying.
2. The minimum credit score to get approved is a 680. A good credit score is 720+.
3. Prepare all the necessary loan documents, such as Articles of Organization, Operating Agreement and EIN number.
4. Work with a hard money broker who specializes in vacation rental loans and can match you with multiple private lenders.
5. Find an insurance agent that is familiar with vacation rentals or short term rentals.
6. Make sure you have enough funds for the down payment, prepaid interest, title insurance, title search fees, lender fees, etc.
7. Perform a local rental market analysis before applying for a loan.
8. Do not apply for an FHA loan if your income can’t cover both your primary residence and investment property.
9. Do not apply for an FHA loan if you have a bankruptcy, credit card delinquency or collection agency on your credit report.
10. Since traditional lenders run hard pulls on your credit report, running an unnecessary hard pull will lower your credit score.
11. Apply for a DSCR rental loan to purchase a vacation rental. These type of loans are specifically designed for vacation rental investing.

Conventional Loans for Vacation Rentals

In most cases, a conventional loan is used for a home mortgage on a primary residence. These are typically mortgage backed securities that are later resold on the secondary mortgage market.

Strict Qualification Requirements

Since traditional loans are later resold on the secondary market, they tend to come with strict loan requirements. This means providing 2 years of tax returns, 2 years of bank statements, primary home mortgage payments, etc.

Personal Income Requirement

Traditional banks will first sum up your monthly debt obligations. Such as your monthly credit card payments, primary residence mortgage payments, any home equity lines of credit, etc. Then, they will calculate if your income is sufficient enough to cover the vacation rental monthly mortgage payment.

Good Credit Score

A mortgage lender will usually perform a hard pull on your credit report. They will make sure you not only have a good credit score, but also no credit delinquency’s.

Lower Interest Rates

Since they are guaranteed by the lender or a government-sponsored enterprise, such as Freddie Mac and Fannie Mae, they come with lower interest rate payments.

Lower Down Payment

When purchasing vacation rental properties, a 20% down payment is standard. However, traditional lenders allow you to purchase PMI insurance to put down 5% or even 10% at close.

Slow Approval Time Frame

Since these are “conforming” loans, they have to follow the minimum and maximum loan limits set by Freddie Mac and Fannie Mae. Therefore, slowing down the approval process through unnecessary paperwork.

Hard Money Loans for Vacation Rental Property

Hard money loans play a significant role in vacation rental investing. They provide investors with fast access to financing without the need to provide personal income or tax returns. These asset-backed loans are typically offered by private lenders and are secured by the value of the underlying vacation rental.

Faster Closing Process

Compared to traditional bank financing, hard money loans are known for their faster approval process. Since the vacation home market is competitive, the ability to close fast is desirable.

Approval Flexibility

Compared to traditional banks, hard money lenders are often more flexible in their lending criteria. They are primarily concerned with the value of the rental property and the actual or potential income it can generate.

Bridge Financing

Hard money loans help investors purchase vacation rental properties quickly while they work on securing long-term rental loans such as a DSCR rental loan or conventional loan.

Rehab or Renovations

Renovated vacation homes attract more potential renters and maximize rental income. Fix to rent loans are a form of hard money that should be used when financing a vacation home that needs renovations.

Pay Interest Only

These type of asset based loans usually come with 3-24 month loan terms with interest only monthly payments. Interest rates are based on

Interest Rates and Credit Score

A strong credit score and a larger down payment will result in lower interest rates. While a not so good credit score, usually comes with higher interest rates. This can be ideal for self-employed individuals and investors with unconventional financial situations.