Here’s How You Fund a Deal—Before Creating That LLC
Many real estate investors, particularly those who follow a buy-and-hold strategy, use LLCs to help protect and manage their investment properties. Once an LLC is established, investors can purchase, borrow, and manage their properties through the LLC. The primary reason investors use LLCs is to protect their assets and limit their personal liability in the event a lawsuit is filed in relation to one of their properties.
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In addition to limiting liability, there are other advantages to using LLCs, including everything from ease of administration to tax benefits. A potential drawback to LLCs is more restrictive borrowing opportunities. When it comes to borrowing through an LLC, lenders look at and treat loans to LLCs a bit differently than they do to individuals.
How LLCs Are Treated Differently
The biggest difference when borrowing through an LLC is that you won’t be able to obtain government-backed loans (e.g., FHA, VA, etc.) to purchase investment properties. Why? Government-backed mortgage loans are generally intended to help consumers purchase their primary residence, not investment property.
If you hold an investment property in your personal name (not via an LLC) you may be able to get a "conforming" loan (Fannie Mae and Freddie Mac) on your property. But there are limitations to the numbers of properties you can finance via this route.
Although you won’t be able to obtain a government-backed or conforming loan for investment properties through your LLC, you still can get a loan through conventional lenders. Just be prepared to personally guarantee the loan and submit a lot of paperwork. Why? A newly formed LLC lacks established credit and a history of income.
Therefore, the lender will look at your personal credit and income history to qualify your business (LLC) for a loan, and require that you sign a personal guarantee. In this case, the LLC gives you protection from liability, but you are personally on the hook for the loan.
Other Borrowing Options
You may find trying to go the conventional lender route is just too unpleasant with all the paperwork and personal guarantee requirement. If so, here are a few options for borrowing through your LLC.
Assuming the numbers on the deal are solid, you may be able to get a loan through a commercial/portfolio lender. Most commercial/portfolio lenders will still want a personal guarantee on the loan, especially when the business entity has no established credit. However, they may have some flexibility and be willing to work with you if you have a track record of successful deals or you are willing to buy down the loan.
Sometimes an investment property, like in commercial lending situations, will be enough if it has good enough cash flow and signed leases by tenants prior to getting the loan.
Hard Money Lenders
Yes, rates are likely to be higher than conventional loans, but the terms will likely be more flexible as hard money lenders focus more on the collateral property itself than on the borrower.
Tips for Borrowing Through an LLC
Regardless of who you ultimately borrow from, it is a smart move to take steps as early as possible to establish a proven track record and solid credit history for your LLC. The sooner you do this, the sooner you can get out from under the personal guarantee requirement. Some of the ways you can build credit and a proven track record for your LLC are as follows:
- Establish credit lines that will grow with the LLC. Starting out you’ll have to use your or the LLC officer’s credit to gain approval under the business name. But this can build credit for your LLC if you’re using the EIN or corporate tax number.
- Put a free and clear property into your LLC to give the LLC some assets. This allows the LLC to have some
LLC-owned collateral to secure loans to. This strategy does put that property at risk, but if you are a responsible borrower the risk of losing that property will be very low.
If you plan to borrow through your LLC, be sure to know the requirements and, if possible, establish a credit history and proven track record before you need the loan.
What has your experience been like investing through an LLC? What advice would you add?
Share with a comment below!