How to Qualify for a Vacation Home Loan

Question

Hi BP Family,

My partner and I just had to back out of a deal on an STR in Vermont because we were unable to secure 90% LTV with a conventional lender. Since a 10% down payment is obviously the key to unlocking the full potential of investing in STR's and scaling the business, I'm hoping someone can shed some light on how they were able to execute on those loans.

I don't understand how you can start out with this investing strategy without having enough personal income to cover a second mortgage? Am I missing something here? Lenders won't consider any projected STR revenue to qualify the property because it's intended for personal use, right??

Thanks,

Christian

Joshua Strickland · Answer

Full disclosure - I’m not a lender, or cpa, or any of that financial type stuff; but here’s what I’ve learned through many conversations with probably around 10 different lenders… To qualify for a 10% second home loan your DTI ratio will come into play. So you either need to make more or downgrade lifestyle to show your DTI can cover a 2nd home. No rental revenue from the place you’re purchasing will be used in this calculation. However if you get an investment loan (some lenders will do as low as 15%) then the rent revenue of the house you’re purchasing can be used for qualifying purchases. This all depends on the lender of course so if one tells you no, go talk to another.

Seems like your options are:

1. Pony up more $ for the down payment.

2. Bring in a 3rd partner with a lower DTI to qualify for the 10% loan. But 3’s a crowd.

Side note - I have 2 10% down loans in my portfolio because once I could show the income from my first vacation home on my taxes I got a lender to agree to count it toward my DTI. I plan on getting another one next year after I file my taxes as long as I can find a property that will still cash flow 10% down.

Patrick Giblin · Answer

@Christian Canavarro No loan advice here but just a heads up on STR in Vermont. The legislature here has an eye on regulating it significantly. It did not come to pass this year, but I am sure it will be on the agenda again next year. Hopefully your agent has spoken to you about this, as it may impact you down the road if you look to try to do STR in VT. With a smaller population, especially around many mountain towns, there are not a ton of plan B options for these investment if the hammer comes down on STRs

Rohin Dhar · Answer

If you get an investment property loan, the lender will typically count 75% of the projected *long term* rent (from the appraisal) toward offsetting the the debt in your DTI (debt to income) calculation.  If you're getting a second home loan, they won't count any of the projected rent so you need to quality based on your existing DTI. After your STR income is on your tax returns, it helps offset debt DTI calculations on future financings. I guess you could do second home loan with 10% down, but I suspect most will require 20% anyways.

Our lender at least adds back in depreciation when doing our DTI calculation @Joe C. so not a big deal to have paper losses related to the depreciation. However, if you have non-paper losses and excessive write-offs, that will negatively affect your DTI and prevent you from purchasing future properties using conventional debt.

I'm not a mortgage professional, so talk to one to get the exact details. Either way you probably need 20% to get started if you're using conventional debt.

Joshua Strickland · Answer

@Joe C. not sure on that. I had a ton of write offs this year and showed mine barely making any money on paper and it didn’t seem to be an issue for my second one. At the end of the day if you need to offset a $2000/ month mortgage and only are able to show a paper income of $1500 per month that is still a $1500 swing back towards your DTI.

The most important thing I’ve learned with lenders is that they are “real humans” when it comes to analyzing and understanding your situation. They want to make the deal work because that’s how they get paid. Just have to make the calls and do the research to find the right one.

Joe C. · Answer

@Joshua Strickland Wondering if lenders look at income from a property before depreciation or after depreciation? If I push a lot of depreciation into the first few years I technically net out to zero or even a loss but am still pocketing a lot of income.

In other words does a lender look at $30K income with $40K depreciation as $30K income or $0 income?

Joe

Scott K. · Answer

I should also say - 10% isn't the best situation. Usually to get that sort of loan (or less than 20%) you have to pay PMI, and you have to pay a ton of points up front, making your ROI suffer greatly. Your goal should be to maximize your ROI, not lower the down payment.

Scott K. · Answer

Investment properties are harder to finance than homes you live in. Usually the LTV has to be 15%+, depending on how many you own. My first investment prop was 15%. My 2nd, 3rd, and 4th had to be 20%. Now I usually have to hit 25% for them to finance me. It also varies by lender, some are more willing to do lower amounts.

There are plenty of ways to get around this, most of them involve taking loans from people with much higher interest rates, who don't care about the property and will just lend you money. They're called hard money lenders. Rates can go between 10-20%, and usually people plan to do this just for a year, then when the income they have from the rental property qualifies for a conventional loan (usually 1 year) they can apply at a mortgage company and switch over the debt (pay off the hard money lender)

How to Qualify for a Vacation Home Loan

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