How To: Cash out 1-4 unit Property

[Andrew Postell]

Receiving a cash out loan on an investment property can be a very confusing item. This post is designed to bring some clarity to taking cash out of a property with a conventional loan and help you navigate the sometimes-challenging cash out rules for properties. Admittedly, this post will probably be for the mid-level to expert level investor. There could be some important items in here if you are just starting out but it might get confusing in a hurry. If you have any questions, then please reach out. Lots of people on this forum can answer questions and many are very helpful individuals.

We will cover:

1. The conventional rules for a cash out loan
2. Buying a home with cash
3. How to properly structure buying a property with cash

1.  The Conventional Rules For a Cash Out Loan

Fannie Mae and Freddie Mac are the Government Agencies that sponsor conventional lending. Most banks will have these loans as an option. There are other loan types as well but for brevity we will limit this post to the “Conventional” lending (Fannie/Freddie).

• Conventional Loans limit your cash out on an investment property to 75% of the “After Repair Value” on a Single-Family home (70% on a 2-4 unit home). This is also the same percentage that you need for a non-cash out refinance (more on why that is important later).
• If you purchased the investment property with a loan, then conventional loans will require you to wait 6 month to take cash out.
  • This rule does not apply if you purchased the home with CASH (more on that in section 2).

Let’s explore some examples here:

• If you purchased a property with a 15% down conventional loan (85% loan to value) and you wanted to get cash out, you wouldn’t be able to do so since the cash out limit is 75% of the “Loan to Value”. The MAXIMUM cash out you can receive is 75% of the value of the property.
• If you purchased a property with a loan, but did the rehab on with your own cash, then you would need to wait 6 months to get that cash back. Keep in mind you could only receive 75% back of the After Repair Value.  
  • So if you bought a home with a loan of $50k, it required $30k in renovations, and it appraised for $100k after the repair work was complete then….
  • You would refinance the $50k loan, receive back $25k in cash…since $75k would be 75% of the After Repair Value.

2.  Buying a home with Cash

Buying a home with cash has become increasingly popular for many investors but often an investor will be caught with the restrictions to cash out loans if they need to get their money back. There is a plan to avoid this entire section (In section 3) but it is important for us to know about these restrictions. If an investor is buying with cash and flipping they get their money back when they sell the property. But if they are seeking to hold a property for any length of time and want their cash investment back there are some important rules to understand with conventional loan:

• If you buy a property with cash (or with a HELOC) you can receive a cash out loan on Day 1.
  • There is not a 6 month waiting period with receiving a cash out loan if you purchased a home with cash or with a HELOC
  • BUT you will be limited to the amount of….
    • Your purchase price + closing costs (costs when you purchased the home)
    • OR
    • 75% of the “After Repair Value”…

WHICHEVER IS THE LOWER AMOUNT (super important)

These rules are important to understand so here are two examples:

• Example 1: If you purchased a home with $50k of cash, and put $30k of renovations into the loan, and the home was worth $100k. 75% is $75k and $50k is your purchase price. So you could only receive $50k in your first 6 months of ownership since the LOWER amount is your purchase price. After 6 months you could receive the full 75% of the ARV.
• Example 2: If you purchased a home with $80k of cash, put $5k into the home, and the home was worth $100k. 75% would be $75k and your purchase price is $80k…so the lower amount is $75k.

When buying a home with cash you can absolutely get cash back right away but you will be limited to the lower of those two amounts.

3.  HOW TO PROPERLY STRUCTURE BUYING A HOME WITH CASH

With these rules, you can see how it can be confusing to get conventional lending when buying a home with cash but there is absolutely a proper method to structuring your deals when buying cash. Here’s the secret:

• Create an LLC and have the LLC lend you a mortgage on the property you are receiving.

The reason why this works is because instead of you needing cash or receiving a cash out loan, we are now refinancing a loan – your loan. There no reason to wait any time or have any “whichever is lower” rule come into play. We are just refinancing a loan.

Here’s how it works:

• You create an LLC
• You buy a home
• Your LLC gives you a loan for the home
• You file the deed for that loan at the county courthouse
• You use the money from the LLC to buy and fix up the property
• Once the property is completed, your conventional lender comes to refinance the loan
• Your conventional lender runs title and sees there is a loan.
• Your conventional lender refinances you into a new loan, and cuts a check to your LLC…a check in the amount of 75% of the value.

Please don't confuse this 75% with a "cash out" amount. The non-cash out LTV on a refinance is also 75%. We are refinancing a mortgage. Your LLC's mortgage. Essentially your LLC has become the bank/hard money lender/etc. However you want to think about it. You get to set the interest rate (it can be 0%) and you get your investment amount back sooner.

Some things to think of:

• To file a deed at the county courthouse is $100-$150 in cost (depending on which county)
• And you want that note to be pretty close to 70% of the ARV for the property if you don't want to bring any money to closing. 70% will allow you to roll in your closing costs. If you want it to be at 75% just keep in mind you would need to bring your closing costs out of your pocket to complete the refinance.

This was a lot of information. Feel free to ask additional questions if you need. Thanks!

[Stephen Gregory]

Non-Arm's Length Transactions

Non-arm's length transactions are purchase transactions in which there is a relationship or business affiliation between the seller and the buyer of the property. Fannie Mae allows non-arm’s length transactions for the purchase of existing properties unless specifically forbidden for the particular scenario, such as delayed financing. For the purchase of newly constructed properties, if the borrower has a relationship or business affiliation (any ownership interest, or employment) with the builder, developer, or seller of the property, Fannie Mae will only purchase mortgage loans secured by a principal residence. Fannie Mae will not purchase mortgage loans on newly constructed homes secured by a second home or investment property if the borrower has a relationship or business affiliation with the builder, developer, or seller of the property.

[Stephen Gregory]

It seams like you either have to be a lawyer or mortgage professional to know what the language means but it was this part, "such as delayed financing" that got to me.

[Jeff Kieszkowski]

Everything was going good until I read those last 2 posts. I have been looking at using a HELOC to purchase and flip my first house . I was under the impression I could buy for 25K put in 20K and get it all back on a conventional Loan. I was not aware of the 6 month wait. This helped clear some things up Great Post.

[Michael Henry]

Thank you for the post; so much great information from the members on this site!  

[Andrew Postell]

@Stephen Gregory sorry for the delay in responding here.  Try using the @ to tag people and we will certainly get notification that you were speaking to us.  @Jeff Kieszkowski for example (I wanted to tag you so you could read this as well).  

A non-arms length transaction is describing who you are purchasing the home from. This post does not address that topic. You will still be buying a property from "X" party (but not you) your LLC replaces the "cash" in your transaction. So think of using a hard money lender (HML) for example to buy a property. Well, rather than using HML, you are using your company. People buy with cash so that they do not have to pay so many fees to HMLs. Not everybody has cash but when you do you certainly don't want to be giving the cash away. But if you buy with cash, then you have all these OTHER rules that you face (described in Section 2). So the plan here is that you replace your "cash" with your "LLC" mortgage. And let me be very clear here, your LLC is not buying anything. It is just lending you the money.  You are your own lender!  So now we don't have to do any cash out rules, we are just refinancing a mortgage (described in Section 3).  If you have more questions on this feel free to PM me.  Thanks!

[Rocky Griffin]

Very interesting technique with the LLC acting as a lender. I am curious about the tax implications associated with this method. I am finishing two homes as of current and will be looking for another soon and may consider this method.

[Brian Bistolfo]

Anybody done one of these deals and gone the DIY-lending route with their LLC? I've got the LLC ready to go and a property lined up. I suppose the next step would be

1) finding some boilerplate loan documents that I can configure to create the loan and file it, and

2) opening a business bank account for the LLC to operate with (so that the money is coming "from" the LLC).

Can anyone advise as to whether those are the right steps and/or point me toward a resource for item 1?  Thanks!

[Andrew Postell]

@Brian Bistolfo you can just google "note examples" in google and tons of examples will come up.  that's all the title company will need to file the lien.  And the "sourcing" of the funds is not necessary for this strategy.  Nobody will care where the funds came from as long as you show the lien on title.  Hope this helps but feel free to PM with more questions if needed. Thanks!

[Brian Bistolfo]

Thanks @Andrew Postell.  I'll be using this one as a template.

Clearing up a newbie question: are "file the deed for the loan at the county courthouse" and "title company filing the lien" the same step / same thing?

[Andrew Postell]

@Brian Bistolfo yup, same exact things.  That note is a good example.  Since you are lending to yourself essentially you can create your own terms; 0% for example is possible.  Just as long as that note is on the deed to refinance you will be good to refinance from day 1 of ownership.  Thanks!

[Kevin Martin]

@Andrew Postell great post and stradegy for the cash out and the LLC. I understand how it all works but when you go to refinance (regular refi no cash out) will the underwriter see that the current mortgage on the property is from an LLC that is owned by the borrower? Are thier any rules against this or is this something that the underwriter might think is a red flag? I understand the rules for a cash out refinance and regular refinance are different but would you just consider this a "loop hole" to get your 75% LTV and not worry about seasoning?

[Ron H.]

This is possibly regional but many area charge a state or local mortgage tax of from .5% to 1.5% of the loan amount.  What loan amount is recorded at purchase and what loan amount is reported to the new(future) lender?

[Andrew Postell]

@Kevin Martin thanks for the question. I can't speak for every bank here but the Fannie/Freddie guidelines address this very specifically. The LLC thing is not an issue. You can even have a private person listed on the deed as the lien holder. A government entity. An ex-spouse. Etc. So the named entity is not an issue. All sorts of liens can be placed on title. So if you have a lien from an LLC, no issue. But there is a slight issue if you own the company you borrowed money from. The guidelines state that you will be limited to an 80% "Loan to Value" if you are refinancing a lien from an entity which you have an ownership interest in. But since our normal limit is 75% on a cash out loan, 80% is actually BETTER than what our option was previously. And just in case, if you were refinancing a lien NOT held by a company you have ownership interest in your LTV on an Single Family home would be 85%. So a 5% "penalty"...again, it's still better than waiting 6 months and having only 75%.

[Andrew Postell]

@Ron H. yes, absolutely you need to keep in mind any "closing fees" that apply to your state.  Many states only have a "transfer" tax; meaning, you pay a % tax when you transfer ownership.  So weather you have a mortgage or not, you are paying that fee.  But some states, like Florida and Kansas, have a mortgage tax.  So the item that should be considered, when buying with cash, it is better for me to wait 6 months, take 5% less in money, miss other potential real estate deals, to avoid a $.35/100 tax (or whatever your state mortgage tax is)?  Or maybe just use a "portfolio" loan instead of waiting the 6 months...and therefore receiving a higher rate, or a 15 year loan, or an adjustable loan...or all three...to avoid that tax.  Just know the math and you will see the right answer.  Thanks for posting!

[Teague Anderson]

Thank you for this post.  Some super cleaver ideas.

@Andrew Postell

@Andrew Postell, I have an idea for using the personal loan method in conjunction with a 1031.  Could you let me know if this would work:

* Lets say I sell a property for $200k and I make $100k in proceeds and I intend to use a 1031 exchange.

* I find a replacement property for $200k that I get under contract

* I use the $100k of my own money, and take out a $100k loan from a family member (my Mom), and file a lien in her name.

*After closing I go to a bank to refinance the loan.

My question would be, could the bank refi with an 80% LTV, or would they only refinance the amount to repay my mom?

Thanks,

Teague

[Justin Young]

@Andrew Postell, to set up the LLC so that it can lend money, would that be as simple as setting up a business checking account for the LLC then drafting a note stating the terms of the loan?

[Andrew Postell]

@Justin Young setting up the account and the LLC is part of it. You would also need to file the lien on title as well as a part of this strategy.

[Andrew Postell]

@Teague Anderson under your scenario the bank would ONLY refinance the lien from your mom. But if you wanted to get more funds out you would want to have your mom's lien AND create a lien for your money. Then the bank could go higher. You would HAVE to do this at the time of purchase though. When more than 1 lien is present the loans have to be used at purchase in order for them to not be considered a "cash out" loan. Once a cash out loan, then you have to wait 6 months. In order to skip the 6 months, have a lien from your mom, then a 2nd lien from your LLC for $55,000. Then you can pay back your mom, and receive $55k to your LLC. Hope that helps. Thanks!

[Ryan Ellis]

@Andrew Postell thank you for sharing this. In going to try this. My brain hurts a little trying to work it all out though.  :)

I have 4 properties paid in full with cash and 1 paid in full by using a HELOC on my primary residence. All 5 rental properties are currently in my LLC. I'd like to take out conventional loan to repay the HELOC.

If I'm understanding you correctly, I need to loan the money from my LLC to my personal self. It doesn't matter that the LLC isn't actually giving me cash. The LLC is just signing the Deed over to me.

I can then get the loan from the bank?  I’m lost at this point.  Any help would be appreciated.

Thank you again!

Ryan Ellis

[Clint Moore]

@Ryan Ellis to do what he is talking about your LLC needs to sell you personally the property or properties on a recorded land contract for approximately 75% of their value.

@Andrew Postell my question is I personally just purchased a home cash can I transfer it to my S corp then sell it back to myself via hml without any delays or issues arising.

@Rocky Griffin I am also curios about the tax implications of this. Assuming you are using an LLC or S corp will pass thru income you would just have to show how you personally loaned the business money for start up or operating expenses.

Great post very informative and as long as no major tax issues I plan on using the method. 

[Andrew Postell]

@Ryan Ellis you have it 100% correct.  No money needs to transfer or anything like that.  Just file the lien on the deed.  Then it's a "refinance" and not a "cash out" loan.  Makes a world of difference.

[Andrew Postell]

@Clint Moore this is NOT selling your properties back and forth.  Just like when you buy a property, receive a loan from a bank, and close on that property.  This is about receiving a loan from your business. Essentially your business is your lender. That is it.  Since the terms of the loan you receive from your business is up to you, you can receive a 0% interest loan from your business and thus have no income (and no tax) implications from receiving that loan.  Hope this helps.

[Jorge Ruiz]

@Brian Bistolfo

How did it work out?

@Andrew Postell

I PM’d you. 

Best,

Jorge

[Clint Moore]

Originally posted by @Andrew Postell:

@Clint Moore this is NOT selling your properties back and forth.  Just like when you buy a property, receive a loan from a bank, and close on that property.  This is about receiving a loan from your business. Essentially your business is your lender. That is it.  Since the terms of the loan you receive from your business is up to you, you can receive a 0% interest loan from your business and thus have no income (and no tax) implications from receiving that loan.  Hope this helps.

So I live in Indiana, I own a property free and clear, bought it in June 2017. It was recently rehabbed and rented I want to cash out. It's worth roughly $80k and I want around $50k The lender I spoke with said I can't do it because the it is not worth their time and they will not make enough on it. Secondly I asked about your refi strategy and they said any land contract under 1 year would be considered just a new purchase not a refi. Should I talk to another lender or do you have any suggestions. Thanks

[Kerry Baird]

This is where we’ve got to pick up the phone and start calling.  Different lenders have different appetites for different properties.  The small loan balance lender will be more difficult to find, but someone in your local area should know or be that lender.  Sometimes the credit unions will like smaller loans, but rarely will you find a big lender that wants to work with you.