Refinance as an LLC?

Question

Purchasing property for cash. Using private $$ loan for rehab. Will Refi after rehab and/or Seasoning. When going to apply for rehab will lenders allow refi in LLC name? Does refi have to be in personal name?

Vitaliy Volpov · Answer

@Paul LaSpina

I read the advice given in this forum and I feel compelled to comment.  Purchasing a property in your personal name with a Fannie/Freddie loan and then changing title after closing without refinancing into a commercial loan is NOT a good idea and will not further your goals of liability protection at the least possible cost (I am inferring that those are your goals from the question).  First, most, if not all lenders, who issue Fannie/Freddie loans will have a "due on sale" or "due on transfer" clause in the note.  This means that if a property is transferred to someone else, including an LLC in which you are the sole member, it will be considered a default and will trigger the payment of the entire remaining balance of the loan, usually within a very short period of time (think 30 to 90 days).

Some people say, "well, the bank will never know that I transferred it.  As long as I make my monthly payments, they won't care and will turn a blind eye to it even if they find out."  This may be true.  I have seen this happen.  Some banks do not care and I know people who have done this and have continued to carry the Fannie/Freddie loan even after their LLC became the title owner.

However, there is still another problem here.  Namely, the purpose of having an LLC -- liability protection -- is severely undermined by the fact that there is financing on the property in the individual member's name.  Most people drastically misunderstand what an LLC actually is and how it provides protection.  Just because a property is owned in an LLC does not mean that you are protected from all liability no matter what other circumstances exist.  Specifically, there is a concept in the law (this definitely applies in New York) called "piercing the corporate veil."  Without getting too deep into legalese, it means that a plaintiff can get around the protections of the LLC and get at the assets of the LLC's individual members by showing that the LLC and the members are really one in the same; that there is no actual distinction between the entity and the individual.

One of the ways that a plaintiff can do this is by showing that there is co-mingling of funds and obligations between the LLC and the member.  This would include taking money from the LLC without following proper formalities, such as creating documentation that the withdrawals were distributions of profit; collecting rent and putting it into the individual member's bank account as opposed to the LLC's bank account; making personal purchases with the LLC's debit card; and -- you guessed it -- having financing in your personal name tied to the property which you hold in your LLC.  Armed with these facts, the plaintiff can keep you and all of your assets in the lawsuit and potentially make you not only sell the subject property, but may also force to sell other properties, or hand over the money in your personal bank accounts, garnish your wages, etc.

So, the long and short of it is, if you decide to go with option 2, just know that you are likely undermining the very purpose for having your LLC be the title owner in the first place.  As anything in the legal world, there are no absolutes.  It is possible that you could convince a judge that the fact that you have financing in your own name on the building does not mean that your LLC was a sham or that there is no separation (especially, if you followed all the other corporate formalities and otherwise kept your funds separate from those of the LLC), but I think your chances of being able to keep your personal assets out of a lawsuit will be greatly diminished in such a case.

Personally, I would go with the commercial financing as the terms are not that much worse than Fannie/Freddie financing, at least in upstate New York.  That is, unless, you don't mind owning the asset in your personal name and just making sure you have rock solid insurance to fall back on, in the unlikely even that you are involved in a catastrophic lawsuit at some point during your ownership of the asset.

Andrew Postell · Answer

@Joshua Lidberg first, great job on researching topics from 2 years ago!  Wow!  But this is one of the great benefits to Bigger Pockets; you can research everything for as far back as you like.  Now, the answer to your question is that most lenders just don't know very much when it comes to real estate investing.  For most, they write about 1 investment property loan for every 50 primary home loans.  And in the mortgage industry, the average loan officer writes 3 loans per month....so 1 investment property every 2 years??  Yup, that's the crux of it.  Now, they will all say "I write investment properties"....but try asking them how to structure a "sub to" deal that you want to house hack while doing the BRRRR method and see what they do.  They don't speak our language, know how to structure things, or even have the proper information on how to advise you.  So keep sticking to Bigger Pockets but also lean on LOCAL investors and ask which lenders they use.  Relying on locals will help you find investor friendly lenders.  Even thought I described the "average" lender there are investor friendly lenders...but they are just harder to find.

Now I need to elaborate further to really address what you are asking. Generally speaking there are 2 main types of loans for investors:  “Conventional” and “Portfolio”.  Again, not everyone will know the difference here but you will after this.

Conventional - I'll define these as loans that come from Fannie Mae and Freddie Mac (if you recognize those names).  These loans are all 30 year fixed rate loans.  They have the lowest rates we can find and since they are 30 year fixed...they allow us to cash flow better...which helps us qualify for other loans later. The draw back to these loans is that they are more paperwork heavy than the other "portfolio" types of loans....but if you have ever received a loan on your primary home, it's likely that you will go through the same type of paperwork here with conventional lending.  Fannie/Freddie money = Fannie/Freddie rules.  NOT the bank's own money.  These REQUIRE you to close in your personal name.

Portfolio - I'll define these loans as loans that come from the bank's own "portfolio" of money.  Sometimes referred to as "commercial" loans.  These loans are a lot more flexible than "conventional" loans.  Bank's money = Bank's rules.  If they like you, then maybe they will lend to you.  But since there is a limit to how much money the bank has access to....their rate will be higher...and usually a shorter term.  The most common portfolio style loan in Texas is a 20 year adjustable rate loan.  These loans are easier to get but the terms are different.  These COULD require to close in your personal name....but most are totally ok with closing in your LLC.

Fannie/Freddie types of loans will be available everywhere and those rules might change SLIGHTLY between lenders.  Portfolio loans can run the gambit.  Since each lender controls it’s own money you will have to call around to ALL the banks to learn about all the programs.  A mortgage broker will help with this some…but even the best mortgage brokers don’t have access to ALL portfolio loans out there.

Keep in mind that OWNING the property is completely separate from WHO IS RESPONSIBLE FOR PAYING THE LOAN.  In theory, you could own the home...and I am responsible for the loan.  They are not mutually exclusive.  So if you are wanting a loan that only your LLC is responsible for....that's a Portfolio/Commercial style loan.  Just be prepared for "different" terms.

*WHEW*  I hope all of this helps in some way.  Thanks!

Andrew Postell · Answer

@Paul LaSpina thanks for this post.  I have 2 suggestions here:

• Buying a property with cash and then refinancing can get SUPER confusing really quickly.  Fannie/Freddie loans have the best rates but also the most rules to them as well.  I wrote an article on this subject and how to properly buy a property with cash HERE
• There are several methods of placing a property in an LLC.  You can close in your personal name with a Fannie/Freddie loan and then change title after closing.  This is generally the most popular method.  So, close in your name, then switch title.  You receive the best loan you can find with this strategy.  You can also find a loan type that will allow you to close in your LLC.  This loan type will have a higher rate, an adjustable rate, and might be a 20 year loan...and sometimes its all three.

Lots to know about so feel free to tag me and ask questions if you need.  Thanks!

Tom S. · Answer

@Joshua Lidberg  Just chiming in as a investor with multiple commercial loans for rental properties.  They don't report to my personal credit, however, when applying for a new loan, you're supposed to disclose it on the Personal Financial Statement since you're personally guaranteeing the loan.  And for tax purposes, the LLC is disregarded and the rental income and expenses go on Sch E of your personal tax return.  So any lender requesting your tax returns will see it there as well.

Andrew Postell · Answer

@Joshua Lidberg as I mentioned the most common commercial loan type in Texas is a 20 year adjustable rate loan.  That's what most local lenders offer for their commercial loan product.

Joshua Lidberg · Answer

Thank you for getting back to me @Andrew Postell. A lot of great information here on BiggerPockets. I'm now in the process of going through your thread with 200 or so replies, "How To: Cash out 1-4 unit Property", I'm sure I will find a lot of very useful info there.

A portfolio loan is exactly what I am looking for. I mean, I have been researching all of those topics for a long time now. Maybe too long. So I was very surprised when more than 1 lender told me that even if my company takes out financing and I guarantee the debt, it will still show on my credit. Not sure if this was a misunderstanding issue, or lack of knowledge issue, as I met them at an REIA event and they claimed to work with a lot of local investors.

The property I'm looking to cashout-refi was bought in cash as an REO, and I fully renovated it. I bought it in my personal name a little over a year ago, and it's already rented out. There is currently no note on it. Since I bought it in my personal name, I'm looking to quick claim it to the LLC, and then finance it in the name of the LLC. I understand that the terms would not be as appealing as on a conforming mortgage, but I'm prepared for that; there is enough room to still cashflow.

As you said, when banks lend out their own money, they can dictate their own rules. I understand that everyone will have different terms, especially in different states and for different assets. However, would you say that there are average terms that you most frequently come across from portfolio lenders? I'm interested in terms of length, ARM vs Fixed (type of ARM, if more frequent), and interest. The property is a SFH. If there are, so to say, most common terms that you come across in such situations, I would be very interested to learn them so I can reference to something when contacting small local banks and credit unions in the upcoming days. Thanks. Your posts benefit a lot of people!

Dan Gamache · Answer

@Joshua Lidberg If you take a loan in an LLC with a private/commercial lender it should not show up on your personal credit report (you most likely will have to personal guarantee). I can only speak for who I work with, but I think it's across the board it won't show up on credit. If you take out in personal name & transfer to LLC it will appear on personal credit & other creditors may want to see proof of payoff.

Joshua Lidberg · Answer

Thank you, @Dan Gamache. You summarized exactly what I was thinking. I can't imagine as to why some industry "professionals" would tell me otherwise. I guess I'll have to find lenders/brokers who are more familiar with commercial lending process.

Joshua Lidberg · Answer

@Andrew Postell, a few mortgage brokers have suggested to me a strategy of financing in personal name, and then transferring the property to an LLC. For me, liability protection is not even the primary goal with putting a property into an LLC, as this could be accomplished by insurance and additional umbrella policies. For me, the primary goal is to keep the debt off of my credit. I precisely explained this to the brokers I spoke with, yet they are suggesting that the loan will show up on my credit either way. I believe this is incorrect. If the property is financed and owned by the LLC, and I guarantee the loan, I should not have this debt reflected on my credit unless the LLC defaults on the loan. This is because I would be a guarantor, not a co-borrower. Yes, a credit inquiry would show when the lending institution checks my creditworthiness, but I don't believe the actual debt would reflect on my personal credit. What is your take on my situation? And do you think that financing in personal name to later transfer the property to an LLC, defeats the purpose of the entity? Would be interested in your opinion.

Refinance as an LLC?

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