With the rise in the short-term vacation rental market, which reached a value of $109.76 billion in 2022 and is projected to grow by over 11% annually through 2030, more real estate investors are turning to properties like Airbnbs.
A great option for financing these investments is a DSCR (Debt Service Coverage Ratio) loan. Unlike traditional loans that focus on the borrower’s job or income, a DSCR loan looks at how well the property can generate enough rental income to cover the loan payments. This makes it an ideal choice for short-term rental investments.
In this article, we’ll explore why DSCR loans work well for short-term rental properties and what you need to do to qualify for one.
What is a DSCR Loan and Its Implications?
A DSCR loan, or Debt Service Coverage Ratio loan, is a financing option for real estate investors primarily. As a traditional loan focuses on the borrower’s credit profile, a DSCR loan focuses on cash flow generated by the investment property. It helps in determining if the income generated from renting the property can cover the loan payments. DSCR Formula: Net Operating Income/Total Debt Service Let’s understand this through an example: if property generates $130,000 annually in NOI and total debt service is $1,00,000, then DSCR will be 1.3, which means property generates 30% more income than is needed to cover the debt obligations. DSCR Loan Implications for short-term rental are given below:| DSCR Ratio | Description for Short-Term Rentals | Risk Level for Lenders |
| 1.0 | Due to seasonal fluctuations, short-term rentals may struggle during off-peak periods. | Moderate Level |
| Below than 1.0 | Income falls short of debt service due to inconsistent bookings and low occupancy. | High Level |
| Greater than 1.0 | Income exceeds debt obligations; high occupancy and stable cash flow despite seasonal fluctuations. | Low Level |
How do I Qualify for a DSCR Loan for Short Term Rentals? A Comprehensive Guide
Listed below are 5 qualification requirements for DSCR loans in short-term rentals or Airbnb: #1: Property’s Cash Flow Must Meet DSCR Requirements The borrower should make sure that Airbnb or short-term rental property generates enough cash flow to cover debt service, which is the main need for a DSCR loan. When evaluating a short-term rental, the Debt Service Coverage Ratio is usually between 1.2 and 1.5. The DSCR below 1 is not accepted and considered poor. #2: Provide Proof of Rental Income or Projections For established short-term rentals, lenders require proof of income through rental history or tax returns from previous years. For new properties without a rental history, borrowers can present projections based on the local market data to qualify for the loan. Lenders look for a consistent income that will cover the property’s debt service.What Is The List Of Documents DSCR Lenders Will Ask When Applying For Loan For Short Term Rentals Or Airbnb?
Listed below are key documents lenders may ask when applying for DSCR loan for Airbnb or short term rentals:- Airbnb Income Statements
- Leases or Rental Agreements
- Occupancy Rate Reports
- Booking History
- Comparative Market Analysis (CMA)
- Property Appraisal
- Property Management Plan
- Short-Term Rental Insurance
- Debt Schedule
- Business Plan (if required)
- Refinancing the DSCR loan after property appreciation happens.
- Selling the property once the market value increases.
- Improving rental income by optimizing Airbnb’s strategy.
What Key Factors Should Borrowers Compare When Choosing a DSCR Lender for Short-Term Rentals or Airbnb?
When considering a DSCR (Debt Service Coverage Ratio) loan for short-term rentals or Airbnb properties, borrowers must evaluate factors like:- Loan-to-Value Ratio
- Loan Terms and Flexibility
- Fees and Closing Costs
- Experience with Short Term Rentals
- Customer Service and Support
- Down Payment Requirements
- Minimum DSCR Requirements
Why is a DSCR Loan Perfect for Airbnb and Short-Term Rentals?
Listed below are a few key points highlighting why DSCR loans are perfect for short term rentals like Airbnb:- Income-Based Qualification: DSCR loans focus on income generated by the property compared to the employment history. Airbnb properties have fluctuating income due to seasonal demand, the lenders qualify the investors if the property can meet rental income or exceed the minimum DSCR which is 1.2.
- Higher Income Potential for Short-Term Rentals: As compared to traditional leases, short term rentals have high income potential due to seasonal demand, holidays, events, etc. For example, a long-term rental might bring in $1,500 per month, but an Airbnb at $150 per night with a 70% occupancy rate can generate over $3,000 per month. The higher income helps improve the DSCR, making short-term rentals a more viable option for DSCR loans.
- Better Terms for Higher DSCR Ratio: If the DSCR is higher, the loan is considered less risky for the lender. Due to the high DSCR ratio, lenders can offer lower interest rates, longer repayment terms, higher loan-to-value (LTV) ratios, etc. If the short term rental is well managed, it can generate a higher DSCR, leading to better loan terms.
“Comparison of short-term rentals vs. long-term rentals, highlighting higher income, flexible pricing, and greater cash flow for short-term rentals”
How DSCR Loans Differ for Short-Term vs. Commercial Rentals?
The table below compares various factors to give a clear difference between how DSCR loans differ for short term and commercial rentals for borrowers:| Factor | Short-Term Rentals | Commercial Rentals |
| Loan Purpose | Financing properties listed on platforms like Airbnb | Financing properties used for business operations. |
| DSCR Down Payment Requirements | DSCR between 1.2-1.3 due to higher income potential | DSCR between 1.3-1.5, to ensure sufficient income coverage |
| Interest Rates | Potentially higher interest rates due to perceived risk | Typically lower interest rates due to stable income streams |
| Loan Terms | Often shorter terms (5-15 years) with flexibility for refinancing | Longer terms (10-30 years) with fixed repayment schedules |
| Down Payment | May require lower down payments (15-25% of property value) | Generally requires higher down payments (25-30% of property value) |
| Income Calculation | Based on projected rental income, often more volatile due to seasonal occupancy | Based on stable, historical income from tenants, typically less volatile |
| LTV Ratios | LTV ratios typically between 70%-80% | LTV ratios generally lower (60%-75%) due to risk considerations |
| Occupancy Requirements | More emphasis on occupancy rates and seasonal trends | Steady occupancy expected, typically based on long-term leases |
