About 5 months ago, I began my journey into Real Estate and I came across Bigger Pockets. It’s help to completely transform my life and goals. Reading the forums, the recommended books, and talking to other BP members has convinced me that Real Estate investing will be a big part of my future.
I've been working with a partner and we're getting closer to doing our first deal, and I was hoping to get some help from BP members.
My REI partner has applied and been preapproved for a loan. Terms:
- 30 year
- 20% LTV for a SFR
- 25% LTV for a Multifamily
- $60,000 Loan (could be more but this is what we asked for)
- Closing costs about 6%
- Property taxes must be prepaid (as part of the monthly payment) for the first year
This is a loan he applied for in his name only. The mortgage broker knows that he plans to invest in an out-of-state investment property with partners.
If we invested together with others using his loan, how would the process work?
We were thinking:
- My friend would get the loan in his name
- The four of us would split the down payment / repair costs, if any
- We'd put the deed of the house into an LLC that's shared equally among the 4 partners
I know that transferring title runs the risk of the Due on Sales Clause.
- Is there a way around this by using "estate planning"?
I've been reading through other forum posts but most of what I have read are about more complicated deal structures.
Anyways, if anyone has any input, I'd appreciate it.
A couple of additional notes:
- We'll be investing from abroad (though we're both US citizens, we work abroad). Our partners would include people on the ground where we want to invest.
- It was difficult getting the loan as overseas investors! It probably took over two months. We were able to impress our Loan Officer, however, by using knowledge from BP to put together a good loan binder. @Ben Leyvovich 's CFFU course, @Jesse Gonzalez in CA's guidance on Fannie Mae, and @Bill Gulley 's post on Loan Binders were all great sources of information re: the Loan Binder.
Jesse Gonzalez's info on Fannie Mae:
Bill Gulley's Post:
(If anyone has thoughts on the Loan Terms, too, I'd love to hear them.)
Hey @Daniel Ryu
Congratulations on getting the loan.
I believe that is how it would work, just put it under the LLC's name.
The loan has to have a personal signature, so they are personally responsible for the loan.
The only question I have, Have you discussed splitting the loan payment, if you run red for a time?
I know that may seem like a trivial question. I was talking to someone before about partnering, but their theory was if you get a loan. It's your responsibility, even though it was for the business. Needless to say we didn't partner up.
What if you left the property deeded in his name and had a contractual agreement that he treats the property as if it were owned by the partnership? He could execute a 2nd mortgage on the property in favor of the partnership to secure his obligations. I've never seen this structure - just an idea to avoid issues with the lender. I'm curious what others think here. Individual ownership provides a tremendous advantage because the individual can get a conforming loan, while a partnership or LLC cannot. It would be a sweet setup if you could pool resources to increase purchasing power and still take advantage of Fannie Mae subsidized financing.
@John Van Uytven
Thanks John! Ben's mom's sister hooked us up with a realtor who hooked us up with a lender.
We'll still need to work out details if we end up doing a JV. But good question! Hope I get a chance to see you sometime. I wanna hear about how that deal you made is progressing.
Thanks for your input. I'm wondering about this statement: "He could execute a 2nd mortgage on the property in favor of the partnership to secure his obligations."
"execute a 2nd mortgage" = getting a 2nd mortgage on the home - basically refinancing, right?
"in favor of the partnership" = not sure what this means?
Sounds interesting.. could you provide a few more details?
You have several issues going on here:
1. The mortgage paper in question sounds like a conforming Fannie/Freddie note. I am sure that this contains Acceleration and Due on Sale Clauses - when you deed the property into an LLC you trigger those clauses, which give bank the right to accelerate re-payment and call the note due. Unless you clear this in writing with the lender, I'd be cautious around this.
2. If Ben is applying for the mortgage on his own and then planning to give you interest in the property based on down-payment, this also triggers Due on Sale. This is called Fractional Interest transfer.
3. Essentially, if you are working with a vanilla broker specializing in residential mortgages, your best bet is to put yourself on the application with Ben. You will still have to keep the deed in both of your names and not the LLC so as to avoid triggering DOS, but the problem of defining interest remains as the LLC was supposed to take care of that - right? This is messy...how much do you trust Ben and the other people?
By "mortgage", I'm not referring to a loan. I mean an instrument you file in the county records to show there is a lien on the property. This prevents your partner from selling the property without paying off your interest.
Here's how I'm envisioning the transaction:
1. Your partner buys the property, deeded in his name, with a loan in his name.
2. Your partner sells you a contractual interest in the property. For example, you pay him an amount equal to half the cash he has invested in the deal, and the two of you agree to share equally in all net profits and losses from the property, and the net proceeds from a sale.
3. Your partner executes a mortgage on the property, which you file in the county records, giving you a lien on the property so that your partner cannot sell the property without your consent.
Note that your partner would have to come up with the entire down payment himself, and you would buy in after the loan closed. You don't want to commit mortgage fraud.
As @Ben Leybovich points out, my suggestion would be a "fractional interest transfer" and technically violate the due on sale clause. But I don't see any way the bank could find out about it.
As always, thanks for your insights. I'm so glad I'm one of your students!
Looks like I have some more research to do!
If anyone else has more insights, I'd love to hear them. Thanks as always to everyone on BP.
I am just not comfortable with the notion of "student" - how about a slightly more experienced colleague...?
I am blessed to have been around some highly competent people. One of them, an attorney, once told me that the first and most important rule 1st year law students are taught is - Don't Mess with Banks and Insurance Companies - such is the GOLDEN RULE. He who has the gold makes the rules, and the banks and insurance companies have all of the gold...
If Daniel followed your advice he would not be breaking law - per se, but he would be violating a couple of clauses which opens him and his partners up to liability. If he has cash in the bank to be able to cash out the underlying note in case the it is called, then I suppose he could play the cat and mouse game. But, he does not have this type of cash!
Due on Sale is big deal in my book, especially with other people's investment capital in the pot, such as what Daniel is planning on doing. I think that you might consider being a bit less "loose" with your advice to newbies who may not be aware of all of the risks involved... Saying "the bank wouldn't find out" implies the cat and mouse game that in my opinion is a dangerous one!
No problem, my slightly more experienced colleague! (I think it's more than "slight" though ^^)
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