Financing Your Hostel Business
How to Start a Hostel Series
So you want to start a hostel business? You’ve defined the dream, now its time to find the cash.
In this section of the series “How To Start a Hostel” we are going to try and simplify and elucidate the complex world of financing your hostel business.
Although we can not give financial advice or specific terms and rates (as they vary from country to country), we hope to give you a very clear idea of what the options are and which options best suit your personal situation.
Types of Loans
Standard Bank Loan / Small Business Loan
Standard bank loans or more specifically here a small business loan, are usually the first port of call for any individual who is looking for the amount of capital required to buy a property out right.
You should approach your own bank rather than a bank with which you have no history as they are less likely to give you a loan.
Unfortunately only around 20% of small businesses will qualify for this type of loan and if you have no previous experience in the industry then you can be reasonably certain that you will not qualify for this type of loan.
Fortunately starting a hostel business means that almost all of the capital will go into the building itself rather than depreciable assets within it, such as furnishings. As the property is almost always likely to go up in value and the bank can re-possess it at any time it makes you a low risk prospect when compared to a business that will spend most of its capital on stock, research or marketing.
The following information is for a rough guide only, all of these details will be dependent on region, lender and your personal situation.
Rates: 5 – 15%
Term: Up to 25 Years
Fees: Medium Costs
For country specific information search “business loan rates and terms” followed by the country you plan to operate in.
The SBA does not lend the money directly, you still loan the money from a private lender but the SBA takes out most of the risk by agreeing to pay back the majority of the loan if your business defaults. Through this mechanism private lenders will lend businesses money that they otherwise would not.
If you are in the US I would strongly advise looking into this option, all the information can be found at their official site: www.sba.gov.
For detailed information on their terms and rates see here:
SBA Terms and Rates
If you don’t have a great credit score, experience in the industry or much of your own capital this could be the option for you.
A micro-loan is just that, a small loan usually ranging from $500 to $50,000 issued by a micro-lender. Therefore a micro-loan will not be enough to buy a property but may be enough to furnish and set up your business if you already own or rent the property.
Big banks don’t usually deal with loans this small so organisations are set up to offer micro-loans that usually require lower application standards than a normal bank loan. Due to this, interest rates are higher than a normal bank loan.
To find out more information about micro-loans in your region search “micro-lenders” followed by the country you are operating in.
Personal or self financing is not an option for everyone but it may be more achievable than you think. You may have the cash yourself to set up the business or you may have someone in your family that is willing to support your project.
The most common way of personal financing is to get a home equity loan against the part of the mortgage that you have already paid off. The advantage of this is that banks will be more willing to loan you the money as its backed by an asset but the disadvantage is that if you default on the loan you could lose your house.
As your loan is backed by an asset the rates are usually relatively low on these types of loans and the interest that you will pay on the loan is tax deductible up to $100,000 (US specific).
A Path To Buying
If there is no option for you to raise enough capital to buy a property for your hostel but you have the perfect property in mind then there is a “path” to buying your property out right. All is needed is a little bit of patience…
Lets say you see the perfect property for your hostel business, a beautiful building with all the facilities needed nestled in the right part of town. The owner of the property wants to sell it but you have been to the banks and you can not get a loan.
If you can raise enough capital to convert the property into a hostel business and pay the first 3-6 months rent, you could approach the owner and rent with the option to buy. This way you can run your hostel for say 3-5 years relatively risk free, then after this period go back to the bank with a profitable business, a better credit score and the necessary experience.
The difference between lending someone the capital to start a business which they have never run, in a property / location that has not been validated. Compared to someone who is already running a successful business in that property / location – is night and day. You will now have experience, you will have a proven business concept and if you took out a loan in the beginning you will have a better credit score.
This option is the perfect path for a new hostel owner, and not just because of the finances. It allows you to get your feet wet, find out whether its really for you and most importantly it allows you to learn and make mistakes without the pressure of a big loan and mortgage payments.
What You Will Need When Applying
Whether you are borrowing money or not it is essential to put together a business plan. There is not a lender on the planet that will loan money to someone without a comprehensive business plan.
A business plan for a hostel is no different than any other business plan as the format is the same it is just the content that differs.
There is a wealth of information online already so rather than repeating it all in this article here are the most helpful resources to get started:
This is the only online business plan that is specifically for hostels:
The link above gives you an outline but the following article will explain each section in detail and give example content for each section:
Finally, to give you an idea of what the finished product should look like here is a full business plan for a bed and breakfast business:
When applying for a loan, experience is essential. Any business that has been operating for less than two years is considered a startup. It will be very difficult to get a traditional bank loan if you are starting from scratch (applying for the loan to buy or furnish a property). This does not mean it is impossible it just means that your options will be limited and you will probably pay a higher APR.
Any experience in the hospitality industry will help towards this but really you need to have already run a hostel to be considered to have experience when starting a hostel business.
Credit ScoreWhen a bank is reviewing a small business loan application they will take into account the credit score of anyone who has a 20% or higher stake in the business. If you do not already have a good credit score you have almost no chance of borrowing money. With an alternative lender you may be able to get a loan with a credit score of just 500 but the best terms and rates will be awarded to people with a credit score of at least 720. To find out your personal credit score you will have to check the credit reference agencies within your country. To find these simply search “credit reference agencies” followed by your country. Alternatively you can simply search “check credit score” from your local search engine.
“Collateral is a property or other asset that a borrower offers as a way for a lender to secure the loan. If the borrower stops making the promised loan payments, the lender can seize the collateral to recoup its losses.” – investopedia.com
The more collateral you have upfront not only means that the lender can recoup some of its losses but it also demonstrates your commitment to the business.
Collateral usually comes in the form of “asset based collateral”, things such as home equity or any other real estate equity, cash or equipment. In this sense it is something that the lender can liquidate to recoup some of the loss.
Another form of collateral is a personal guarantee. A personal guarantee is a contract that you sign with the lender that makes your current and future wealth available to them until the time that you have fully re-paid the loan.
This is not a contract that should be taken lightly, and you should never sign anything such as this without your lawyer having read through the contract and explain to you in detail exactly what you are signing.
A “Lien” is similar to a personal guarantee except that it gives the lender the legal right to re-posses assets within the business if you default on the loan.
There are clearly many options available and you have to decide which options fit your personal situation the best. Before you even consider financing you must make a few decisions about your business.
- Will you buy or rent?
- Do you need to renovate the building?
- How much will it cost to set up the hostel?
- Will you need cash to cover the first 3-6 months of wages and running costs?
- What personal assets do you currently have?
- What is your credit score?
Writing a business plan is not only essential for any financing but writing it will help you answer the crucial questions listed above.
One of the most important considerations you need to take into account is your experience level within this industry. If you are very experienced and already have a tried and tested business model then buying a premises may be for you. If however you are starting out for the first time it is a huge commitment to take on the amount of debt needed to buy a property.
Hopefully this article has made the path to financing your dream a lot clearer, and narrowed down the myriad of options to a few choices that suit your personal situation.
In the next article we are going to talk about