Could LLC harm the chance of getting mortgage?

Question

I was just talking to a CPA about setting up an LLC to hold my investment property.  He cautioned me of this approach (although he thinks it makes sense from asset protection stand point) lenders may not give me mortgage.  Since so many of you out there holding investment properties in LLCs, there must be a way.  Any tips?

Ryan Webber · Answer

Conventional lenders will either not loan to LLC's or will give you a hickey on your rate for it.  Either way if and when you are using a conventional lender, you can do the loan in your personal name and then deed it to your LLC for asset protection and estate planning purposes.  Legally (what I have read and heard but I'm not a lawyer) a lender cannot enforce the due on sale clause if you deed a property into an entity.  Supposedly the St. Germain Act of 1982 or so gave protection to individuals who were deeding the properties into their own entities for estate planning purposes.  I would recommend discussing the matter with a qualified attorney.

Ryan Webber · Answer

The bank is not going to check the title again to sell the note, so I don't think it will be a problem when they are selling it on the secondary.  And again, I believe you have legal protection from the due-on-sale clause to transfer into an entity for estate planning purposes via the St. Germain Act.

Either way very few banks will enforce the due-on-sale clause if you are making the payments on time.  I know several investors that do subject to's in which they are in direct violation of the due-on-sale clause, and I have only heard of one time in which an investor was even threatened with foreclosure.  Foreclosure is a huge costly pain for a bank and just getting a low interest loan off of the books would not seem like a high enough return to go through the entire foreclosure and resell process.  There is also a 90% chance that the loan has been sold off like Chris outlined, so I doubt the "big" boys that buy pooled mortgages on the secondary market are going to look very far into it.  They have bigger fish to fry.

BBC, a conventional lender is your common mortgage broker and most residential loan officers at a bank.  An "unconventional" lender is rather a commercial lender.  You would find them in the commercial department of a bank.  They can do "non-conforming" loans.  Non-conforming being that the note will not be sold on the secondary market, and the lender therefore can with a lot of latitude determine what the terms of the loan will be.  These loans are kept in house and are not resold.  A loan that is designed to be resold on the secondary market must "conform" to many very specific requirements to be resold.

N/A N/A · Answer

But that's in the current economic climate. There hasn't been a large jump in interest rates, so the motivation hasn't been there. Imagine a year or two of 70s-style inflation. A loan at 7% when inflation is 12% is pretty expensive, too. The whole motivation for DOSs was to help lenders clear low-interest loans when interest rates go up. We just haven't had the right situation to see mass-invocation of these clauses. To date, they have largely been used to protect lenders from getting stuck with a different borrower than that which they originally signed up for. When that's the only issue, then yes, they will be happy with the note as long as it is performing. But I think it's naive to think that it will always be that way, even if rates shoot up.

My (limited) understanding of that law is that (1) it was written to specifically enhance the lenders' ability to enforce DOS and (2) the exemption to which you refer is for a living trust in which the original borrower is a beneficiary. I'm not familiar with it applying to an LLC, but I don't know that much about its application (and doubt that there have been many challenges to it because of the current economic climate anyway).

Maiko Miyake · Answer

Thanks everyone for insights.  This has been very educational.  I contacted two reputable lawyers and am waiting to hear from them.  will keep you posted!!

Chris Sanders · Answer

That's a possibility.  If they want to sell off the lower interest loans to go after new paper, there may be a problem.  I don't believe they would call it due though.  They'd probably force him to return it to his name so it could be sold or threaten to call it due.  As I said, there can be problems.  You have to weigh then against the benefits of keeping it in an LLC...

Chris Sanders · Answer

Ryan,

I am a mortgage broker and I've learned a lot about this in the last few months.  I have a borrower who owns a investment property in the US Virgin Islands.  He holds every single property he owns in a separate LLC for tax/legal/liability issues, and he's a Harvard CPA.

However, this presents MANY problems when you try and refinance or purchase.  Nearly every mortgage loan is sold on the secondary market.  So Lender A will fund your mortgage loan and then sell it to large institutional investors.  Well these investors will not purchase loans that close in the name of an LLC, which is why nearly every lender can't do it.

To get a mortgage that will close in an LLC, you have to find a "Portfolio Investor/Lender".  These are lenders who DO NOT sell their mortgages on the secondary market.  These lenders are typically banks.

In my borrower's case, he's going to close in his name and then transfer back into the LLC.  Now technically, if the lender found out he did that they could call the loan due.  But they obviously won't find out as long as he's making his payments.  The kicker is the transfer taxes.  Since he's transfering ownership from the LLC to himself, he's subject to the tax from the county/territory.

So while there are many benefits to keeping it in the LLC, when it comes to refinancing it can be a real hassle.

Hope that helps...

Danny Kay · Answer

I have heard about this also, its a good thing to do. But as he said, technically the bank could call the loan due. In this cause you would deed the property to your person again, and make the bank happy. Then deed it back to the LLC after the bank is happy. But remember banks want to be paid, so if your are making payments, the chances of them calling the loan due is slim to none. Now remember, i am not a CPA, attorney or anything with cool letters at the end of my business card; its just what i have learned.

N/A N/A · Answer

It's not so obvious to me. What if interest rates go up quite a bit over the next year or two and the lender wants to get some low-interest loans off the books? Even if the payments are coming in, the lender may wish to use any excuse to call the loan due, get the money back, and re-loan that money at the higher rate.

I think at that time it may be too late, but you'd have to look at the specific contract.

Maiko Miyake · Answer

Hi Ryan,

Whor are conventional lenders, and who are NOT conventional?  any pros and cons?

Maiko Miyake · Answer

Thanks for this.  The CPA I spoke to was also saying that I would not be able to transfer the deed, but he is not a lawyer and I will certainly check with a competent attorney.  Is there a section on this website where I can find referrals of attorneys?  I checked out Real Estate Services section, but did not find much...