What You Need to Know About Applying for a Short-Term Rental Loan

If you’re considering purchasing a property for short-term rental or refinancing an existing one, it’s essential to understand the specific challenges that come with financing this type of investment. While short-term rentals, like Airbnb or holiday homes, are often advertised as highly profitable, securing financing can be more complicated than many people expect.

In this email, we’ll explore why many banks hesitate to lend on short-term rental properties, whether the earnings from these rentals are as high as they seem, and why lenders require 1-2 years of financial records before considering refinancing. We’ll also discuss strategies some investors use to get around these restrictions and whether they’re a smart choice.

The Challenge of Securing a Short-Term Rental Loan

Short-term rentals are a unique type of property investment because the income generated from them can be highly inconsistent. Many investors enter the market with dreams of high returns based on popular rental platforms like Airbnb or Vrbo. However, while these platforms can generate impressive earnings during peak seasons, many banks remain skeptical about financing short-term rental properties for several reasons:

1. Inconsistent Cash Flow:
   • Short-term rental income can be volatile. Certain periods of the year—holidays, weekends, or peak seasons—might generate high returns, while other times may bring in much lower income or none at all. This unpredictability makes it difficult for banks to assess the stability of your income, which is critical for loan approval.
   • For example, a mountain cabin may be fully booked in the winter, but sit empty during the summer. Banks prefer investments that offer stable, predictable income over those with seasonal fluctuations, leading them to view short-term rentals as a riskier proposition.
2. Short-Term Rentals Are Riskier to Banks:
   • Banks generally see short-term rentals as a higher-risk investment compared to long-term rentals. While long-term leases provide a steady and predictable rental income, short-term rentals rely on a constant flow of guests, which is not guaranteed. External factors like economic downturns, travel restrictions, or global events (such as the COVID-19 pandemic) can dramatically reduce bookings, adding another layer of uncertainty for lenders.
   • Additionally, banks often worry about how quickly a short-term rental property could be rented out on a long-term basis if the short-term rental market were to dry up. This is why they tend to favor long-term, tenant-based properties, which provide a more secure revenue stream.
3. Perceived vs. Actual Earnings:
   • Many investors boast about the potential income from short-term rentals, but the reality can be quite different once all the expenses are accounted for. While a property may generate $5,000 in gross income per month, after deducting cleaning fees, platform fees, maintenance, utilities, and other expenses, the actual net profit may be much lower.
   • Banks don’t just look at the gross income—they are far more concerned with your net income, or what’s left over after all expenses. It’s not uncommon for first-time investors to be surprised at how much their costs eat into what they initially thought was high income. If you’re considering this type of investment, it’s worth reading about the hidden costs of Airbnb ownership so you have a realistic understanding of your bottom line before applying for financing.
4. Why Banks Want Proven Financials:
   • One of the biggest reasons banks are hesitant to lend on short-term rentals is the lack of solid financial history for these properties. Lenders typically want to see 1-2 years of financial records before they’ll consider a loan or refinance. This is because financial history provides proof that the property consistently generates enough income to cover its mortgage payments and associated costs.
   • Why this matters: If your short-term rental is less than a year old, banks won’t have enough data to assess its long-term performance. They’re less willing to lend based on projections or hypothetical earnings that haven’t been proven through actual rental history.
   • Seasonality and sustainability: By reviewing 1-2 years of financials, banks can see how well your property performs through different seasons and in varying economic conditions. This helps them understand if your property can maintain profitability even during off-peak months.

Can You Really Make That Much Money From Short-Term Rentals?

Short-term rentals can certainly be profitable, but it’s important to be realistic. Here’s a closer look at the true profitability of these properties:

1. High Operating Costs: Short-term rentals come with frequent turnover, meaning you’ll face regular expenses for cleaning, maintenance, utilities, and supplies for guests. Additionally, platforms like Airbnb and Vrbo charge hosting fees, which further reduce your bottom line.
2. Fluctuating Occupancy Rates: It’s tempting to calculate potential income based on 100% occupancy, but the reality is far more variable. Occupancy rates tend to drop during off-peak months, and even during peak seasons, unexpected cancellations or vacancies can occur.
3. Price Competition: In popular markets, short-term rental owners often find themselves lowering rates to stay competitive, especially as more properties enter the market. This race to the bottom can quickly erode your profitability.
4. Tax Implications: Many short-term rental owners don’t account for the higher tax burden associated with this type of income. Banks will factor these taxes into their calculations when determining whether your property is truly profitable.

Why Lenders Require 1-2 Years of Financials for Refinancing

If you’ve owned your short-term rental property for less than a year and are looking to refinance, you may find it challenging to secure a deal. Lenders typically won’t consider refinancing unless you can provide 1-2 years of financial records. Here’s why:

• Stability and Profitability: Lenders need to see that your property generates consistent income over time. A financial history of at least 12-24 months helps them understand how well the property performs in different seasons and whether the income is sustainable in the long term.
• Risk Management: Banks want to ensure they’re not taking on too much risk. If your property only has a few months of strong performance (say, during a holiday season), that doesn’t give the bank enough confidence that it will continue to perform well year-round. Having a full financial record allows them to assess the long-term viability of your short-term rental.

How Some Investors Try to Get Around Lending Restrictions

To overcome the difficulty of securing loans for short-term rentals, some investors will apply for loans under the guise of purchasing a traditional investment property with proposed long-term rental income. They use normal rental figures in their applications to meet the bank’s lending criteria.

While this strategy may seem like a quick fix, it’s important to understand the risks involved:

• Misrepresentation: If your plan is to operate the property as a short-term rental but you’ve provided long-term rental figures to the bank, this could be seen as misrepresentation. This could potentially cause issues down the line if the lender finds out that the income source is not what was originally stated.
• Future Refinancing Challenges: If your short-term rental performs well, but you don’t have accurate financial records to back up your original claims, you could face challenges when trying to refinance or secure additional financing for future properties. Banks want transparency, and inconsistent information could damage your credibility.

Conclusion: What This Means for Your Short-Term Rental Loan Application

While short-term rentals can be a rewarding investment, they present unique challenges when it comes to financing. Banks are often hesitant to lend on properties with inconsistent income streams and high operational costs, and they require 1-2 years of financial records to prove long-term profitability. Additionally, while some investors attempt to work around these restrictions by applying for traditional investment property loans with proposed long-term rental figures, this approach comes with risks.

If you’re looking to secure a loan or refinance a short-term rental, it’s crucial to have a solid understanding of the property’s financial performance, be realistic about its earnings, and provide accurate documentation. Being prepared will not only increase your chances of securing financing but will also set you up for long-term success.