This is my first post outside of the newbie introductions, so I apologize if this isn't in the correct forum. I've been listening to podcasts and reading forums and articles for what seems like forever, yet there are still several aspects of investing I have questions about. I've tried to personally reach out to some real estate professionals I know, but I feel like I've been brushed off. If I can't talk to people I actually know and can meet with, I hope Bigger Pockets will be able to help.
My biggest obstacle to getting started has been understanding my financing options. My two-prong question is about HELOCs.
1. We have lived in our home for about 2.5 years now. We have a private mortgage with a family member, but we have no official documentation showing we have a mortgage. If I were to apply for a HELOC, how would the private mortgage affect my equity in the house? Do I have to live in my home for a minimum amount of time before banks would consider giving me a HELOC?
2. I plan to set up an LLC for investing. I assume I would not be able to receive a HELOC on my primary residence through an LLC, but is there a way I can transfer it to an LLC once I'm approved? Is there any way to minimize personal risk while still using a HELOC?
Are my questions showing my ignorance? Do I not understand HELOCs as much as I think?
1) you can apply for a HELOC the day you take possession of your house. You must disclose the private mortgage to the HELOC lender. To do otherwise would be fraud. So the private mortgage will count against equity just like a conventional one would.
2) The HELOC will be in your name but you can then lend the money to the LLC. If everything is set up properly, with the proper documentation, my understanding is that it should hold up just fine. There is a lot involved with that though to make sure it's done right.
Thanks for the response Edward. Am I correct in my understanding that I would typically only receive 70-80% of the equity I possess in a HELOC? So two years into a mortgage would not give me much equity to work with. So while there wouldn't be a minimum amount of time I'd have to live in my home, the longer I live here and pay off my mortgage, the more I'd likely be approved for, correct?
@Sean Daugherty , some banks/credit unions will lend upto 90% on primary. You just have to do some research as to which one in your doing 90%.
Just a tip:
Most banks lend up to 80% LTV. So, if your mortgage is $50,000 and market value is $100,000, they (most banks) would only lend you up to $30,000. Which in this case means you are only able to borrow 60% of your equity.
Thanks for the great insight. I appreciate it.
Hey @Sean Daugherty , you didn't tag me so I didn't realize you had a follow up question. On a primary residence I believe you can still find places that will lend up to 90% It will be at a higher rate but if you use the money correctly that should not be a huge concern, just something you need to factor in.
The more you pay down on your primary mortgage and the more your home appreciates, the more equity you will have and the more you will be able to borrow.
The answer to your second question is having adequate insurance coverage. A LLC is not necessary starting out and will only cost you more money and make borrowing money more difficult. Forget the LLC for now and simply have sufficient insurance coverage on your investment properties.
Chances are out of all the members on BP probably less than 1% has ever actually required the protection of their LLC. It is a insignificant number and likely their insurance more than adequate protected them.
@Edward B. Sorry I didn't know how to tag in my responses. I'll be sure to use it from now on. Thanks for the heads up.
@Thomas S. Wouldn't creating an LLC protect my personal assets beyond insurance? My wife is overly concerned about losing everything we own if I invest in real estate. When I mentioned creating an LLC she seemed to be more receptive to the idea. Besides minimizing my personal liabilities, aren't there tax benefits that would justify any additional expenses? Are there other LLC expenses besides initial filing costs I'm unaware of?
I can't thank you guys enough for your help. I don't know why I was so hesitant to make posts when I first signed up for BP this summer.
@Sean Daugherty , yes a properly established and run LLC will protect you beyond insurance. And yes, @Thomas S. , is correct it is probably overkill. But then so is insurance. If it provides piece of mind then it may be worth it. Only you can decide that. I would also offer up that many folks are not sued simply because they have the LLC and it discourages lawsuits. I can say that because you cannot prove a negative. Like that guns prevent crimes or that unicorns exist. Prove they don't.
I have put my properties into LLCs in addition to insurance because I believe that both are an important part of an overall strategy. However, I am not just starting out and do have assets to protect. I have not always had this structure and I was never sued. I could talk more about the pros and cons of entities and insurance but it is an argument that has been played out many many times in the forums. If you have specific questions I will be happy to address them to the best of my ability.
In terms of tax benefits, a buy and hold entity is typically pass through so you do not realize any tax advantages that you otherwise wouldn't simply by holding the property in your name. There are other benefits. A modicum of anonymity, although that is easily by passed. A more professional appearance. Access to business lending down the road once your business entity has a well established track record of making money. And some other stuff.
In addition to the initial set up fees, which can be in the $1k-$3k range if you do it properly you will also have annual fees with the state. This should be no more than a couple hundred dollars but can be as high as $800 in places like CA. You also need to maintain a separate bank account and books etc. and your accountant may charge more if they file a separate return for the LLC or just because. Insurance may be more expensive. Financing will definitely be more expensive.
Bottom line, only you can decide if it is worth it. Along with the professionals you trust to help make these decisions (CPA, Attorney, Financial Planner, Insurance Agent, what have you.)
Sorry it isn't more black and white.
Without going into a lot of details about the LLC. The short answer is no for any protection.
No tax benefits.
Insurance for your liability. And buy at the right price so you can always sell if you run into financial problems.
@Edward B. , I understand very little is black and white in REI. That is one of the things that draws me to it, there's more than one way to go about it. I appreciate the honest insight. My biggest reasons for an LLC would be peace of mind and professionalism. But you brought up several points that I will have to research and think about more before making a decision. It seems I do not have to have this in place when I first start though anyway, so I have some time to decide if it's right for me.
Hey @Sean Daugherty , Great name by the way. Some lenders i.e. Capital one, TD will go up to 90% LTV for a HELOC. I know this for sure as I did one with Cap 1 about 6 months ago. 50K (first 10 yrs interest only) last 20 years interest/principal. Interest rate variable starting at 4.5%. This is soft ball man! Go get it and turn 50K into 150K
@Shawn Ackerman Thanks for the motivation and the compliment on the name. I'm ready to go get it like you wouldn't believe. I'm trying to get as many ducks in a row as I can, but I know I'm going to have to just jump in at some point. I've already set my deadline for the spring to get my first deal done. I'd like to have one in place before that though. I know once I start I'll be hooked.
LOL!!! @Sean Daugherty your already hooked my friend. I'd suggest narrowing down a market(zip code(s)) and learn as much as you can about that area. You will have to JUMP at some point but equip yourself with adequate tools for the tool belt. Have you begun analyzing deals regularly?
I am a CPA and a real estate investor. You asked really good questions. I just wanted to say that there are distnct advantages and disadvantages of each type of LLC. Remember that an LLC is an asset protection strategy. I speak at REIA meetings a lot over the last 12 years, and people have heard me say "Now that you formed your LLC, how do you want to be taxed - partnership, S Corp, C-Corp or what"? I own some property in some partnership LLC's and some personally. What's best? THe answer is most defintely: It depends. It depends on your own unique economic facts and circumstances. When we consult with a new real estate investor, thats the forst thing I do is compare and contrast entity selection, to get things off in the rigiht direction.
About the LTV (Loan to value - how much you can get from the equity) you will find banks and mortgage companies who will lend you 60-90 per cent, but the snag is this: The more you borrow, the greater the bank's risk, and that reflects in the interest rate. More LTV usually means more interest, so if you;re trying to max off make sure you can pay it off faster or your reward (profit) will end up in the bank's pocket.
Jim Kennedy CPA
@Jim Kennedy Great insight. Man, I'm so glad I turned to BP. I'm thinking I should just take whatever I can get with a HELOC and make it work. I hadn't planned on it to fully fund a deal, but rather to help with a down payment and/or rehab costs. But would a bank consider a HELOC used for a down payment as another loan and potentially deny a mortgage? We had a lender say that when my in-laws loaned us money toward a down payment on our home, so we ended up solely using a private mortgage because of it.
@Sean Daugherty , so remember that the banks job is to lend money to people who DON'T need it. I once did a three hour seminar for the SJREIA on how to get your financing. After all is said and done, the bank's biggest concern is this: Hey - how are you gonna pay us back? Private loan or recorded mortgage, heloc or credit card, they factor it all in. My firm shows investors how to craft a spreadsheet showing how the cash flow will support the debt and then some. Now you are building your credibility in two areas - First, the numbers, obviously, but next is the sneaky part: Their perception. Even though its 2016, everybody still judges everybody. With some banks your sort of guilty till proven innocent, so when you show them that spreadsheet, you go to integrity booster #2 - serious investor who understands money. This is a big plus in your favor, though it won;t show up in writing anywhere. Show the monthly PITI (principal, interest, taxes and insurance) PLUS the heloc are covered by your rent. That's why its important to get the right rents, and get the rents right. WE counsel clients on simple ratio analysis when before you even by the house to see if the deal is a winner or a wiener!
Jim Kennedy, CPA
@Jim Kennedy I've been told more than once about making my money at the beginning, before I even make the deal. I'm trying to analyze deals and solidify my understanding of the numbers so I can speak intelligently to banks and/or investors. My biggest fear is borrowing money from a friend or family member and not being able to return their money with interest, so I want to be sure I know going in that I'll be able to do so. Appreciate the insight.
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