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How to Finance Your Short-Term Rental Property

This week’s PhREI guest post is from short-term rental expert Ian Cook of Carpe Diem MD. He’s going to show us how to finance a short-term rental property. This is something that Selenid and I are actively considering so I love learning all I can from Ian.

Also, don’t forget to join the waitlist for The Carpe Diem Short Term Rental Course to learn everything you need to know to become a successful short term rental investor!

Take it away Ian!

One way to purchase your STR is with cash.  If you are in that category you can stop reading.  You have made it to the next level.… For the rest of us please see below…

Securing the right financing for your STR can make or break a deal.  Put simply, you need to be able to finance your rental property. In today’s seller’s market you will want to have a pre-approval letter from your broker before making an offer.  The amount you put down will depend on your market and competition.   If you can put 10% down that would be the best way to start but there are some downsides. 

short term rental property finance

10% Down

First, 10% down will decrease your cash flow…  (I think it is worth taking a little less cash flow to free up more capital).  

Second, in today’s market a 10% down may hurt your offer but can be explained by a good agent or a letter.  You would need to relay to the seller that you are choosing a 10% down to allow for additional investments not because you are stretching to purchase the property.  

Lastly, 10% down does not work for every market and that will be explained as we cover Conforming vs Non-conforming loans. 

An additional note about 10% purchases is that you cannot use a 10% down for a pure investment property.  An investment property would require 25% down and may have a slightly higher interest rate.  The advantage of an investment loan is that your STR is clearly an investment so there would be no questions regarding your intent.

If you purchase a 2nd home with 10% you would need to do so with the intent to use the property for personal use.  Things can change and you may chose to rent this property.  However, you will want to confirm that if you change the classification of your 2nd Home to an STR that you can perform a cost segregation and bonus depreciation without impacting your mortgage.

A 10% down would be a more nuanced position, while a 25% down investment loan would be straightforward.

We recommend you consult with your CPA and mortgage broker early in your 2nd home/STR search.

Conforming vs. Non-Conforming loans

The main two loan categories that you will experience when purchasing a Short-Term Rental property is conforming and non-conforming loans. 

Conforming loan is a loan amount that is “equal to or below” the maximum limit set by the Federal Housing Finance Agency (FHFA) and meets Fannie Mae and Freddie Mac lending criteria.  

Any loan above these limits will be considered a Jumbo loan (Non-conforming).  The limits set by the FHFA vary by County.  You can look up your county at the FHFA website to see your limit.  We downloaded the PDF from this site (click here).  The FHFA lists all the limits for every County in every State.

The FHFA limits will influence your ability to place a 10% down.  For example in Big Bear, California the Conforming limit is the FHFA base limit of $548,250 because Big Bear is located in San Bernardino County.   Therefore, the max loan that you can qualify with a 10% down would be $603,075. 

Meanwhile, a home in Park City, Utah located in Summit County has a Conforming Limit of $817,650.  In Park City you can qualify for a $899,415 mortgage with 10% down.  

contract diagnostics review

So in today’s market the Conforming limits can make or break a deal

A beautiful Big Bear home at $750,000 would require just over $200,000 down or 26% down to meet the Conforming limit criteria.  While a Park City property with a movie theater listed for $900k will require 10% down $90,000.

There are ways to achieve a 10% down via a non-conforming loan AKA Jumbo Loan. However, many of those products are not available now during the covid era.  Many of the current products package in a second loan at a higher interest rate to supplement the down payment.  In the end it can be done, but might break the deal. 

Another way to “decrease” your downpayment is via tax planning. By combining self management with cost segregation and bonus depreciation you can decrease you tax burden. If you factor in your tax savings then maybe the math on $750,000 property with 26% down will work for you. (Click here to learn more about Cost Segregation studies and bonus depreciation.)

Below are the links to Fannie Mae and Freddie Mac with the listed mortgage requirements for 2nd homes.

To summarize these requirements:

  1. The owner for some portion of the year must occupy the property.
  2. The property cannot be subject to any agreements that give a management firm control over the occupancy of the property
  3. The borrower must have exclusive control over the property
  4. Loans are restricted to one-unit dwellings

Freddie Mac Second Home Eligibility Requirements

Fannie Mae Second Home Eligibility Requirements

Good luck and happy 2nd home/STR hunting.

What do you think? How do you finance a rental property? Have you invested in short term or long term rental properties yet? Let us know in the comments below!

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    Jordan Frey MD, a plastic surgeon in Buffalo, NY, is one of the fastest-growing physician finance bloggers in the world. See how he went from financially clueless to increasing his net worth by $1M in 1 year and how you can do the same! Feel free to send Jordan a message at [email protected]

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