Summary: If you’re a real estate investor and looking to invest in a short-term rental, you’re probably planning to finance it with a 10% down second home loan. This is a highly attractive option because it gets you into the investment with so little money down and it allows you to stretch your money into multiple short-term rentals. But what happens when you hit the limits of what you can borrow? What are your options at that point? That’s what we’ll cover in this article and more!
[Disclaimer: We are not accountants, lawyers or financial advisors, so please consult your own team of professionals about the topics covered in this article.]
If you’re in the market for a short-term rental, one of the first things you’ll need to figure out is: How do I get financing for my short-term rental? And what are my options?
This is an especially important question for our community of real estate investors because they’re well past buying their first rental property. Many already own several properties and they’re running into the limits of they’re borrowing capacity. Some are looking to go bigger and looking to buy a small boutique hotel or a large retreat with dozens of cabins.
So in this article, we’ll not only cover options for beginning investors but also for the experienced investor who is looking to scale up significantly.
Start by Downloading our Free Short-Term Rental Cash-on-Cash Calculator
Fannie/Freddie Second Home Loan
One of the most attractive things about short-term rentals as an investment is the low barrier to entry. If you’re a W2 wage earner and have a high income, you can easily qualify for a second home loan and put down as little as 10%.
So imagine being able to buy a $500,000 short-term rental for only $50,000. This makes short-term rentals accessible even if you’re a recent graduate and just starting your first job.
So what exactly is a Fannie/Freddie second home loan?
The loan product is backed by Fannie Mae or Freddie Mac. These are government backed organizations that create a marketplace for loans to be bought and sold. The effect is to significantly expand lending opportunities across the country.
What you really need to know is that these loans are associated with a ton of rules. And second home loans are no exceptions.
I’m not going to cover all of the rules here but two of the rules you need to be aware of are the loan limits and limits on renting out your second home.
In terms of the loan limits, you can only borrow up to a certain amount. In 2023, the loan limit is $726,200 for most of the U.S.
So if you are hoping to use a Fannie/Freddie second home loan for a $1 million short-term rental, you’re out of luck because $900,000 is well beyond this limit.
The second home loan also limits the number of days you can rent your property for the first 12 months of ownership to 180 days. So this loan option might not be for you if you’re wanting to have it rented for more than 180 days.
How Many Fannie/Freddie Second Home Loans Can You Get?
If you’re an investor, you’re going to want to know the answer to this question.
Like many things in life, the answer is, it depends.
You can technically get up to 10 second home loans. However, there are going to be some restrictions as well as reserve requirements.
The biggest restriction is your debt-to-income ratio. You can calculate that ratio by dividing your total monthly debt payments by your gross monthly income. Lenders will limit you to a certain amount of debt relative to your income.
One of the benefits of investing in long-term rentals is that you can lower this ratio with rents. However, you generally can’t do that with a short-term rental because the rents aren’t as reliable as they are with a long-term lease.
In terms of reserve requirements, as you add more units, you have to have a certain amount of liquid funds set aside and documented. This means you need not only the down payment, but also additional funds available at closing. So as you grow your portfolio of short-term rentals, you’ll need to keep this reserve requirement in mind.
Jumbo Loans
Jumbo loans are loans that exceed the limits we described above. As a result, they are considered non-conforming loans and they aren’t backed by Fannie Mae or Freddie Mac.
Like the second home loans described above, you can find lenders who will allow you to put down as little as 10%.
Your debt-to-income ratio and the number of financed properties you own determine how much you can borrow and how many jumbo loans you can have.
Jumbo loans are sometimes associated with higher interest rates and greater requirements, like a higher credit score or lower debt to income ratio. But this isn’t always the case. Like commercial loans, described below, the terms are highly variable so it sometimes pays to shop around.
Commercial Loans
As mentioned above, commercial loan products are extremely variable. Due to the fact that they aren’t governed by Fannie/Freddie rules, they vary widely.
You can find low money down doctor loans. You can find second home loan products like the ones described above.
The key to finding a good loan is relationships. If you have a good relationship with a lender, they’ll figure out a way to fund you.
Also it’s important to note that commercial loans are a great option for those who don’t have a W2 job. Maybe you have 1099 income or you pay yourself in dividends because you own your own practice. Whatever the case may be, commercial lenders can cut through a lot of the red tape and get you the funding you need, especially if they like you! We have a few commercial lending teams within our network. Request an intro here for more information.
Get a Partner
Partnerships often have a bad reputation and for good reason. A lot of partnerships don’t work out. In fact, we avoided them for years.
Not anymore.
What happened? We realized that we were avoiding them because of our own limiting beliefs. Once we realized that our thoughts were getting in the way, we discovered that you can make them work. You just have to set them up the right way AND you need the right partner.
And if you can figure out how to make them work, you can significantly expand your options for financing by finding a “money partner.”
Seller Financing
Another under-utilized approach for financing your purchase is seller financing, also know as a seller carry.
This is when the seller becomes the bank and loans you the money for the purchase.
This can be an attractive arrangement for the seller because they can avoid a big tax bill at the time of sale and instead, pay taxes little by little over time.
This approach to financing is rarely used because buyers seldom ask the seller if they will consider seller financing. If you don’t ask, you’ll never know. So the next time you are in a crunch for funding, consider asking the seller to fund your next deal!
Private Lending
Private lending is often a source of temporary funding but I’m including it on this list because it might be the only option for someone who has stretched their funding sources so thin and have few options left.
The source of these loans is usually private individuals or funds that lend money to real estate investors. They often come with higher interest rates. However, the benefits are that funding can happen pretty quickly. The lending requirements aren’t as onerous as getting a second home loan or commercial loan.
Raise the Money
Typically, this last option is for more experienced investors. A passive investor isn’t going to give you any of their hard earned money if you have no experience.
With that said, we have seen inexperienced investors raise money from friends and family, so we never say never!
The way these deals typically work is, you do all of the work of finding the property, getting it under contract and managing the property. In exchange, you can own 10 to 40% of the property without putting any of your own money into the deal. On top of that, you can charge fees. You can charge fees for pretty much anything. But the most common fees are the acquisition fee, asset management fee and disposition fee.
Keep in mind that this is less investing and more of a job. This is what professional syndicators do for a living. It’s very lucrative, but at the end of the day, you’re trading one job for another.
In Conclusion
So there you have it. A fairly large list of options for financing your short-term rental. Whether it’s your first one or at the point where you have so many, you’re hitting the limits of your debt-to-income ratio.
Where To Go From Here
Want to get into short-term rentals? Join Accelerating Wealth, our short-term rental course.
Want to learn how to build a significant source of income from investing in real estate while reducing your taxes? Join us in one of our courses, Zero to Freedom, or Accelerating Wealth.
