Hosting an Airbnb is highly profitable, but it requires a lot of investment. This blog post will discuss how you can get Airbnb financing.
As people become more comfortable with traveling once again, demand for short-term rentals will bounce back this year. If you are new to investing, it is not too late to buy an Airbnb property. But what if you don’t have enough money to start?
In this blog post, we will examine why new investors should consider getting Airbnb financing, as well as:
- Why lenders are hesitant to finance short-term rental properties
- What types of loans for vacation rental property you can avail
- 5 tips on how you can increase your chances of getting approved for an Airbnb mortgage
What Is Airbnb, and Why Would You Want to Finance It?
Before we go into Airbnb financing, let’s talk about what Airbnb is. The concept of short-term rentals and home-sharing has been around since the 1950s. But when you think of either of these terms, the first thing that comes to mind is usually Airbnb. Airbnb is an online platform that enables both homeowners and travelers to do the following:
- Homeowners can list their rental, confirm bookings, message guests, and withdraw their earnings.
- Travelers can search for and book a short-term rental property, communicate with their hosts, and pay for their booking.
As the service became popular, savvy investors bought houses to put up as short-term rentals. They would then earn three times that of traditional rental income. Since a house is one of the biggest investments one would make, many who would want to get into the industry are looking for short term rental financing.
What Is Airbnb Financing?
Airbnb financing is any type of loan that an investor avails to buy a residential property that they will use as a short-term rental. While there is no type of loan specifically for Airbnb properties, investors would want to know what options are available for them to finance their short-term rental investment.
Because an Airbnb property gets bookings that last from one night to one month, there may be times when you do not have guests and therefore have no income. Lenders see this as risky, because if you fall short of your target monthly income, you may have trouble paying your mortgage.
Thus, securing a vacation rental loan may have different requirements than a mortgage for buying a primary residence. You may have to put a larger down payment, face higher interest rates, or even apply for non-conventional loans.
Why Are Lenders Strict With Airbnb Financing?
Generally speaking, it is more challenging to secure vacation rental property loans. Even before COVID-19 became a pandemic and disrupted the travel industry, lenders have been hesitant to approve loans for this type of property because of the risks that go with it.
3 Airbnb Hosting Risks That May Keep You From Securing a Loan
#1: Liability
When you rent out your property on Airbnb, you are basically letting strangers stay there. Even though you do a background check on your guests by reading their profiles on the website, you are still not 100% sure how things will go during their stay.
So when a guest gets injured while on your property, damages the place, or causes injury to your neighbor, you are liable to resolve these issues, which usually means having to pay. With the right insurance, you can reduce your out-of-pocket expenses related to this issue. But unexpected costs like this may make it difficult for you to keep up with your mortgage payments.
#2: Vacancy and Cancellations
Because most people book an Airbnb for a night, a week, or a month, there may be times when you do not have guests. This is especially true for short-term rentals located in ski towns and coastal areas. You also face the risk of having a guest cancel their booking at the last minute and Airbnb may still refund their money. Because having no guests means earning zero income, this may affect your ability to pay your mortgage.
#3: Secondary Property, Secondary Priority
As an investor, the property you wish to buy and run as an Airbnb will likely not be your primary residence. Lenders consider this risky because should you run into financial difficulties, you are likely to prioritize paying off any bills associated with your primary residence. Secondary homes and investment properties, meanwhile, are usually lower on the priority list, making lenders wary of whom they would loan out to.
What Types of Airbnb Financing Are Available?
If you still want to invest in an Airbnb rental property despite the risks, here are some vacation rental financing options you can apply for:
Mortgage
Investors who have a lot of capital usually buy a new investment property with cash. But if you are new and do not have a lot of funds yet, you can apply for a mortgage to pay for your first Airbnb rental. Many lenders offer a vacation rental mortgage for second homes and investment properties.
Because of the risks of owning an Airbnb property, lenders may have more stringent requirements or even decline your loan application unless you already have prior hosting experience.
Refinancing
If you already own a home that you paid for using a mortgage, you can avail of a cash-out refinance for your short term vacation rental financing. This helps you use the equity in your home to pay for your next investment property in exchange for a larger mortgage. Equity is the amount of your property’s value that you have actually paid off. It can grow in two ways:
- When your home appreciates in value
- When you pay down your mortgage principal through your monthly mortgage payments
This is different from a second mortgage as you are only paying off your old mortgage and replacing it with a new one. You may also refinance your original mortgage and take out a second mortgage at the same time. This means you could take out enough amount from your equity to pay for the down payment, and then use a second mortgage to pay the remaining amount.
Refinancing Example
You bought a home for $180,000 and have already paid off $80,000, with $100,000 left to pay. Over time, your property increased in value by $20,000, bringing your home’s value to $200,000. This means your equity is $80,000 + $20,000 = $100,000.
Let’s say you want to use $90,000 as additional funds to buy an Airbnb property instead of taking out a second mortgage. When you refinance your mortgage, you would then take a part of your equity and then add it to your new mortgage principal. This means your new mortgage would be worth $220,000: the $100,000 remaining from your original mortgage plus the $90,000 you need to take out of your equity to buy a new property.
Home Equity Loan
A home equity loan, also known as second mortgage, allows you to take out another mortgage and use the equity in your home as collateral. The amount that you can borrow depends on how much equity you have, but it may also be lower depending on your credit score and payment history. The sum of your home equity loan amount and your remaining mortgage balance should also be less than 90% of your home’s current market value.
This can be a great way to pay for a new Airbnb property if all of your liquid assets are locked away in your mortgage. Note that you can only use your primary residence or secondary home to take out a home equity loan. Many lenders do not allow equity in investment or commercial properties as collateral.
Home Equity Loan Example
You bought a home for $180,000 and have already paid off $80,000, with $100,000 left to pay. Over time, your property increased in value by $20,000, bringing your home’s value to $200,000. This means your equity is $80,000 + $20,000 = $100,000.
Let’s say your lender is willing to loan you a second mortgage amounting to a maximum of 80% of your equity, which is $80,000. If you have a good credit score and have paid your bills on time, then you may be able to borrow the entire amount.
Small Business Loan
Because you or a property manager you hired are actively managing the rental and offering a service in exchange for money, hosting an Airbnb counts as running a business. Thus, you can take out a small business loan to fund your property purchase. There are many lenders that offer small business loans, some of which are willing to lend up to $5 million. They also tend to require a lower credit score compared to conventional mortgage lenders.
The disadvantages of availing this option depends on the lender you borrow from. Some of them require you to repay as often as every day. Meanwhile, others have loan duration as short as 12 weeks.
Hard Money Loan
A hard money loan allows you to borrow money to buy an Airbnb property, using that same property as collateral. You will not find this type of loan in banks and other conventional lenders; individuals or private investment groups are usually the ones who offer this. Because hard money loans rely on collateral, this is especially helpful for investors with a bad credit score.
However, lenders usually require a lower loan-to-value ratio compared to traditional lenders. Their interest rates also tend to be higher and the loan duration shorter. If you plan on getting this type of loan anyway, try to negotiate a lower monthly payment, then take a cash-out refinancing on your property and use that for your final balloon payment.
5 Tips to Get Approved for Airbnb Financing
No matter what type of loan you wish to avail of, getting the actual approval from the lender requires you to meet certain criteria. Here are tips to increase your chances of getting approved for an Airbnb loan with the best possible terms.
#1: Make Sure That Airbnb Is Allowed in the City and Neighborhood You Wish to Invest in
Before you even get pre-approved or start searching for a property, it is crucial to confirm that short-term rentals like Airbnb are allowed in the location where you wish to buy a property. Some municipalities and HOAs have implemented stringent rules for these types of rental property. For example, some cities only allow owner-occupied rentals, while others allow a maximum number of days in one year for properties to be rented out.
If you did not check this and it turns out that you are not allowed to operate an Airbnb property in the area, lenders are likely to reject your application. And even if you do end up getting approved for a loan, you run a high risk of getting shut down, which may make it difficult for you to pay your mortgage. You may even have a hard time finding a lender in the future should you wish to borrow again to fund your next investment.
#2: Look for a Property With High Profit Potential
As an investor, profitability is the number one feature you should consider when looking for an Airbnb property. If you can prove to your prospective lender that your estimated Airbnb rental income can cover your mortgage payments, they are more likely to approve your loan application. You may even secure a loan with low interest rates.
The most efficient way to find a lucrative property for Airbnb is to use a real estate investment platform like Mashvisor. Here, you can:
- Type in a city on our Property Search page to get an overview of properties for sale in the area.
- Use the heatmap to identify which neighborhoods have the highest Airbnb rental income, Airbnb cash on cash returns, or Airbnb occupancy rate.
- View a neighborhood’s analytics page to find key metrics and optimal rental strategies for that area.
- Use Property Finder to look for the best investment property in up to 5 cities of your choice without opening several tabs on your browser.
- Estimate your investment return on a property based on your income, mortgage, and other expenses using our mortgage calculator and Airbnb investment calculator.
- Print out the Property Analysis Report to show to your lender and increase your chances of getting approved for a mortgage.
- Contact the property seller directly using our messaging feature.
To learn more about how Mashvisor can help you make faster and smarter real estate investment decisions, click here.
#3: Improve Your Credit Score
Unless you are planning to borrow from a hard money lender, you need to make sure that your credit score meets lenders’ requirements. The better your score, the easier it is to get loan approval at a high amount and low-interest rate. If you need to improve your credit score, here are some things you can do:
- Review your credit reports to see what is helping and hurting your score.
- Avoid late payments at all costs.
- Keep your credit cards’ total outstanding balance at 30% or less of your total credit limit.
- Avoid applying for a new credit card or other types of loans for a while.
- If you have a thin credit file, “fatten” it up by using programs that calculate your other financial data—like banking history and utility payments—into your credit score.
#4: Make a Larger Down Payment
The minimum down payment depends on the lender. But if you can afford it, provide a higher down payment amount. This will increase your chances of getting approved with a low interest rate because your large down payment will provide your lender with more security. This will also lower your mortgage payments.
#5: Reduce Your Debt-to-Income Ratio
Aside from your credit score, lenders will also look at your debt-to-income (DTI) ratio. This compares your monthly debt payments to your gross monthly income. This metric shows how much debt you can take on before you are likely to start having financial problems. Each lender may set a different maximum DTI ratio, but it is safest to keep yours around 36%.
If you find that your DTI ratio is higher than this number, or would be higher than this after you take out a loan, you can lower it by doing the following:
- Increase your monthly debt payments to reduce your outstanding debt balance.
- Avoid taking on more debt until you get approved for your loan.
- Avoid using your credit card especially to pay for large transactions.
Getting Airbnb Financing Is Possible With the Right Investment Property
Even though there are no loan types specific for Airbnb financing, you still have several options to choose from. However, because of the risk that comes with running a short-term rental, you may have to provide proof of profitability and excellent financial standing. If you are not able to secure a loan, you can still start investing in short-term rentals with the following options:
- Rent out a portion of your primary residence.
- Start an Airbnb rental arbitrage.
- Buy a second home then rent it out part-time.
- Buy a multifamily property then live in one of the units and rent out the others.
Whichever property you end up renting out on Airbnb, you must first make sure that it will generate enough profit to help you achieve your investment goals. To do that, you need a reliable real estate investment tool.
Click here to try out Mashvisor’s powerful property investment analysis features for 7 days, followed by 15% off your subscription for life.
