Why a business line of credit?

Question

Forgive my ignorance, but I just want to make sure I am thinking correctly.

I have a home equity line of credit that is open and I can draw cash from whenever I want, is a business line of credit along the same theory (except my house is not the collateral) where I draw cash from it as needed for my rental property business?

Also, is your main purpose for having the business line of credit so that you can make cash offers on properties with it and then after purchasing the property set up a loan with the bank to clear the line of credit again?  Thus hopefully being able to close a deal quicker and maybe get a better price since you were able to offer cash.

Ryan B. · Answer

Bryan,

I was thinking the same thing.  $1250 rent means I am setting $625 aside for expenses.

Bryan Hancock · Answer

What magic house gets $1250/month in rents and only $250/month in operating expenses?

The article fails to account for about 30% of the expenses associated with owning a long-term rental.  Buying on terms while paying a premium for the property is inferior to buying for cash and doing a rate and term refinance IMO.  This is especially true with rates as low as they are now.  Why would I use historical 6%ish debt to finance my rental portfolio subject-to when I can get money cheaper by signing for personal recourse?  Why would I pay a PREMIUM for the property using historical debt that costs more?

Seems like a loser to me...unless I plan on defaulting on the seller-financed debt because I can't manager my portfolio properly.

Franklin Romine · Answer

Most unique advantage is the line not being tied to your credit score.  It gets me excited know you have created a business/entity that a bank will loan "unsecured" debt on.  The way I got started was establish a checking account in the LLC, deposit more cash than you withdraw, request portfolio loans, treat the organization with respect and keep to your word and then request the business line.

If your new to a bank don't get to pushy, banks don't want to lend to desperate people.  New borrowers are like a new girlfriend, you take your time because you don't know if it will work out.....

Bryan Hancock · Answer

A business line of credit is underwritten differently.  Lenders also secure the line differently than a HELOC.  Some of the lines are unsecured and thus do not require collateral.

One of the main advantages is that the payment history will count on your business credit scores.  Another big advantage is that you can grow the line over time as your business grows.  Another advantage is that the debt will not drag your personal FICO score down and hamper your ability to secure term debt for refinances for long-term holds.

There are many uses for lines.  We are planning on using it for equity in construction projects and to manage working capital.

Ed L. · Answer

I have seen few  owner finance deals with 0% interest, and none for 8 years.  I just don't see why any seller would commit to such a overly complicated deal unless they were getting wayyyy more than the property is actually worth.  If that is the case then your appreciation would be negated by the over inflated sales price.

That said... It is a very interesting concept that I would never thought of if not for BP.

I still prefer the idea of buying deals with cash & refi that have 30-50% equity.  They also will truly cash flow and not just break even and hope for appreciation.

The best way to avoid default is to buy good deals...

I would honestly rather default and go bankrupt with a bank than default on innocent individuals.  Going bust isn't the end.  I could always use the method described post bankruptcy.

Bryan Hancock · Answer

Another thing is what is described only works if the seller has the equity to finance the loan in that arrangement.  If there is debt on the underlying note the seller would be underwater using the arrangement cited and the investor would still have to come up with the funds to pay off the underlying note.  That is...unless you wanted to sue the seller for specific performance or some such.

I also think that the arrangement cited is taking advantage of a seller and goes against suitability criteria.  Inflating a sales price and doing fancy things with financing is what gives real estate investors a bad name and causes state legislatures to pass nutty laws to curb abusive practices.

Ryan B. · Answer

Frank,

The bank I would use is a small local bank.  I have a pretty good relationship with them already.

I have a checking account, savings account, CD, both kids savings accounts, rental business checking account, our home loan, and a portfolio loan on a rental property all with them.

Jackie Lange · Answer

Here's a great article by Jack Miller which explains why NOT a business line of credit --

It's Not What You Pay, It's How You Pay For It
6/1/2011 8:22:30 PM by Jackie Lange

Different States treat debt obligations differently; so borrowing money to buy houses carries different levels of risk associated with financing.  In California, a person can owe hundreds of thousands of dollars on a house, and if things don’t work out, simply hand the house back to the lender and walk away without any liability.  But, in many States, if you personally guarantee a loan, even after a house is foreclosed, you will still have to pay any losses the lender incurs if the house sells for less than the loan balance.  You could spend years working to repay off what you owe while the interest-clock ticked on.

When I buy a house for resale, I seek financial terms that don’t inflict personal liability for debt.  My favorite target is a house that has an existing loan on it that I can take over with no liability.  Here are some ways I do this:

1.    If I take title by means of a Grant Deed or Warranty Deed, I want to include language to the effect that “the Grantee is taking title SUBJECT TO any liens, encumbrances, encroachments, covenants, easements, and restrictions of records.”

2.    With a Quitclaim Deed, I don’t need to add any of that language because it is implicit in a Quitclaim Deed that I’m only being conveyed the equity that the other person has, subject to any defects of claims on title by others.

3.    As a Trustee, Corporate Officer, LLC Managing Member, if I add “and not individually” after my name, I bear no personal liability for loan repayment, and can hand the property to the lender if I can’t make things work out.

4.    If, instead of borrowing money to buy a property, I give the seller the same down payment, but for an Option to buy the property at an ever increasing price in lieu of paying interest on a risky loan.  Thus, I avoid all liability for any debt.

5.    I can buy the property on a contingent contract, and don’t have to complete the sale unless certain contingencies are removed.  My favorite contingency language is: “The buyer shall not be bound to this contract, and all earnest money shall be returned until the buyer has examined and approved the condition of the premises, the title, and the financial arrangements as of the date of settlement.”  This gives me a lot of last minute leverage to get no-risk financial terms.

Price is critical when I buy a house to resell, but when I buy a house as a long-term rental, financial terms are paramount.  I’m willing to pay more to get seller financing that I can comfortably repay out of rental cash flow.  Suppose a free and clear $200,000 house could be bought for $160,000 for quick cash, but I had to borrow the money at 10% interest-only from a private lender; my payments would be $1,333.33 per month plus another $3,000 or so per year for taxes and insurance.  Let’s say that over a full year, my rents averaged $1,250 per month less about $250 per month in operating expenses.  It’s going to cost me about $4,000 per year to own this house.  I might be able to afford one house like this, but not ten houses.  In other words, negative cash flow seriously limits the total wealth I can build by holding houses for long-term appreciation and amortization.

Suppose, I pay full rental value for the house in return for two things: a small spread on cash flow and zero interest.  Let’s say my financial terms might call for two $100,000 loans:  The first loan to be paid back with payments of $1,000 per month for 100 months.  The second loan to be repaid in a single balloon payment at the end of 100 months.  I would raise this by either refinancing the house or selling it.  The seller will be paid in full in 8.5 years.  Using the same operating expenses, I will break even on my cash flow from day one, and can continue to buy houses.  Comparing these two approaches, if the house appreciated at 5% per year, at the end of 10 years it would be worth $325,779.  In the first instance, I would still owe $160,000 and have paid $40,000 out in negative cash flow.  In the second instance, I would have amortized $100,000 of the debt and have $100,000 debt left to pay.  Over the long term, financing, not the market, is what creates the equity.

Why a business line of credit?

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