Are you unknowingly creating mortgage fraud? Insurance v LLC

Tax, SDIRAs & Cost Segregation
9yFollow

Are you unknowingly creating mortgage fraud? Insurance v LLC

Nick Romano
Boston, MA · Member since 2016 · 47 posts · 7 votes

Hey Guys! I'm closing on my first Multi Family in Mass and I'm told I can't close in an LLC because the banks will not give financing to an LLC (even if I co-sign or guarantee the loan). I have had some people tell me to close in my personal name as an individual then convert the deed (via quick claim, etc) to the LLC after the loan is established. The issue is every mortgage company I've spoken with says this would be fraud or in violation of the mortgage terms and could result in pulling the loan and putting the house into foreclosure.

I spoke with my CPA and he said I will want it in an LLC and he does these conversions all the time. I have also seen multiple people in this forum doing this same process (transferring after the loan closes via conventional financing from personal to LLC).

So my questions is: Are you unknowingly creating mortgage fraud by closing the loan as an individual then putting the deed into an LLC? Is it in unwritten rule that this just what investors do to get conventional loans into LLC's?

Is there some clause that I should put in the loan contract before signing with the lender??

Let me know what you guys think.  Interested to get some opinions here.

Thanks!

0Reply
70 views

Most Popular Reply

Edward B.
Investor · Midlothian, VA · Member since 2015 · 980 posts · 823 votes
9y

It is not mortgage fraud but you are more than likely violating the terms of your contract, i.e. the Due on Sale clause. However, it is up to the lender to exercise their right under that clause to accelerate the loan. Many of them do not. It is an important distinction, though. Fraud would be obtaining the loan under false pretenses. You are not doing that. This is a contract law issue, not a criminal one. The clause is in there for a reason and the remedy is clearly outlined in the contract. It gives them the right, not the obligation, to accelerate the loan. And as mentioned, many choose to just let it go...at least for now. They can exercise that right at any time.

7Reply
See this reply in the discussion

25 Replies

Jump to latestLatest
  • Lynn McGeein
    Real Estate Agent · Virginia Beach, VA · Member since 2012 · 2k+ posts · 1k+ votes
    9y

    We were told this as well.  We decided that if we could pay off the entire loan balance if and when it was called, then we could do that and hope for the best.  We're not usually that liquid, so instead, we just went the route of keeping in our own names and getting lots of insurance, umbrella, etc.  Some are not that concerned about it so do it anyway, but I was taught, Don't speed if you can't afford the ticket.    

    1Reply
  • Edward B.
    Investor · Midlothian, VA · Member since 2015 · 980 posts · 823 votes
    9y

    It is not mortgage fraud but you are more than likely violating the terms of your contract, i.e. the Due on Sale clause. However, it is up to the lender to exercise their right under that clause to accelerate the loan. Many of them do not. It is an important distinction, though. Fraud would be obtaining the loan under false pretenses. You are not doing that. This is a contract law issue, not a criminal one. The clause is in there for a reason and the remedy is clearly outlined in the contract. It gives them the right, not the obligation, to accelerate the loan. And as mentioned, many choose to just let it go...at least for now. They can exercise that right at any time.

    7Reply
  • Jeff B.
    Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    9y

    Use a Commercial Loan to make this easier. You can typically close in the LLC with a personal guarantee -- give it a try.

    3Reply
  • Ronald PerichPro Member
    Investor · Granite City, IL · Member since 2014 · 658 posts · 301 votes
    9y

    Insurance is critical regardless of having assets in an LLC. The real question is who you are dealing with from a banking perspective. Perhaps the state, but almost every area has smaller banks that will lend to investors who keep their assets in an LLC. You just have to look around and make some phone calls.

    It might help if you asked other investors, your CPA, etc. for their recommendation. Your CPA will likely know who other investors they serve use for their loans.

    0Reply
  • Matthew Kreitzer
    Attorney · Winchester, VA · Member since 2015 · 726 posts · 387 votes
    9y

    I am not convinced it is fraud if you disclose the intention to the mortgage company, but that doesn't mean it is a good idea, as they can still accelerate your mortgage if you do so. Talk to a local attorney before making a decision. 

    0Reply
  • Jessica Zolotorofe
    Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes
    9y
    I agree that it's not fraud, but you can't change the deeded owner to anyone other than the borrower. Doesn't work that way. They have to match. Would definitely trigger the due on sale if there is no free assignment provision just like if you sold to a third party.
    0Reply
  • Nick Romano
    OP
    Boston, MA · Member since 2016 · 47 posts · 7 votes
    9y

    @Edward B. great insight.  You're right, just as everyone agrees on this forum, it isn't fraud but simply a breach of contract.  While it will give the option for the lender to call the loan at any time, which could possibly put your house into foreclosure if you can't afford to pay off the loan when called.

    @Jeff B. the problem with commercial loans is they are far less competitive.  

    @Lynn McGeein don't speed if you cant afford the ticket....nice advice:-) 

    My loan will almost surely be sold to Fannie/Freddie because it is a small value conforming loan...maybe the play is to transfer to an LLC after its in Fannie/Freddie hands...(they always let you know via letter/mail when they sell the loan)???  

    While Fannie/Freddie will be able to call the loan at any time (I could afford to pay it off if really needed) maybe they are just not calling the loans right now?  

    I'm still a little confused how everyone is transferring the title/deed on their conventional financing loans from personal to an LLC. A few CPAs said they do it all the time....and people blog about it often here with no repercussions.

    Maybe no one is committing mortgage fraud, but is everyone just breaking the contracts and calling the bluff that these mortgage companies will not call the loan??

    I'm still torn....

    0Reply
  • Jerome Hanson
    Sierra Vista, AZ · Member since 2015 · 56 posts · 25 votes
    9y

    @Nick Romano well, I think we're even going too far when we say that people are "breaking" the contract. It is not a breach of contract because in the contract it states what happens upon sale of the property. In essence you are selling the property to your LLC, which then gives the lender the right to call the loan due. That's a part of the contract, not a breach of it.

    I've taken property subject to the existing loan, which is the same issue and yes it rattles the nerves... but the bank knows and they aren't doing a damned thing about it. Why? Because they know I'm the best shot they have of getting their money and making profit.  No bank wants a foreclosure so to risk calling the loan due would probably be pretty rare.

    Bottom line.. if you're uncomfortable because it COULD happen or it makes you nervous, don't do it.  If you feel you could live with it and take the chance.. go for it.  Comfort level is key.

    1Reply
  • Jeff B.
    Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    9y
    Originally posted by :

    @Jeff B. the problem with commercial loans is they are far less competitive. 

    Yes there's a lower LTV and that's costly, but if the DSCR is right, you can get these every day of the week and you don't have to play the 'creative financing game'.

    2Reply
  • Brett Goldsmith
    Investor · Los Angeles, CA · Member since 2012 · 1k+ posts · 500 votes
    9y

    It would likely trigger the due on sale clause. Most of the time they won't call it due as they are happy when they are getting paid, but they technically could. If they did, potentially placing it back under the individual borrowers name could put the loan back in good standing. 

    Proper disclosure to the necessary parties and consulting your attorney is always invited. 

    0Reply
  • Edward B.
    Investor · Midlothian, VA · Member since 2015 · 980 posts · 823 votes
    9y

    @Nick Romano,

    I agree with @Jerome Hanson. Breach of contract is pretty strong and violating the terms may even be too strong. You are merely exercising your right to transfer the property and they have a clause in the contract giving them the right to accelerate the loan if you do so. That clause protects their investment in many ways and they likely will not exercise it until it is in their best interest to do so. I have heard of lenders/servicers exercising their right to accelerate the loan but it is extremely rare so far. In the very few cases that I have heard of them exercising it, the borrower was also often given the opportunity to remedy the issue vice paying off the loan. That is, transfer the property back into their name.

    It is a roll of the dice though and you are putting all of the power into the lender's court. As many have said if you are not comfortable with that then I would avoid it. But from a moral or ethical standpoint, I see no issue. You all have a contract and each party is merely exercising their rights within that agreement.

    0Reply
  • Jeff B.
    Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    9y

    @Nick Romano, @Jerome Hanson, @Edward B.

    IMO, it is irresponsible to even hint that a due on sale will not be invoked - - you're gambling with someone else's investment and public records.  It doesn't mater if your correct or not, it's leading the reader to taking financial chances.

    0Reply
  • Jerome Hanson
    Sierra Vista, AZ · Member since 2015 · 56 posts · 25 votes
    9y

    @Jeff B. why is it irresponsible to restate what almost every contract will read: that the lender MAY call the loan due on sale upon transfer of the property?

    "It doesn't matter if you're correct or not" Really?

    The contracts themselves hint that the due on sale may not be invoked.  Wording matters in a contract and clearly lenders didn't wanna make it black and white.  There is certainly room for negotiation as shown by the word "may".

    0Reply
  • Edward B.
    Investor · Midlothian, VA · Member since 2015 · 980 posts · 823 votes
    9y

    Actually, @Jeff B., the evidence regarding due on sales clauses is pretty straight forward. No one is hinting that it will not be invoked. In fact, I believe all of us have been pretty up front in terms of the dangers here. The gentleman came here seeking information and we provided it. What would be irresponsible is to withhold our knowledge and experience and leave him to gamble with his investment uninformed.

    1Reply
  • Jeff B.
    Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    9y

    Your experiences (totally anecdotal) are yours, but regardless, if the OP takes your advise and HIS lender does elect to accelerate the loan, the HIS experience becomes fatal.   That's my opinion on irresponsibility, knowingly inducing someone to take a harmful coarse of action.

    Obviously your opinion is contrary.

    @Edward B., @Jerome Hanson

    1Reply
  • Satha Palani
    Investor · Newark NJ · Member since 2012 · 104 posts · 61 votes
    9y

    Does holding an investment property in an LLC really offer that much more protection vs. holding in one's own name and buying liability insurance? i would think a determined tort lawyer would find (has already found) away around limited liability in these cases. If the issue is about protecting other assets from a claim, would it not be better / safer to carry a ton of insurance?

    Wondering if the LLC provides more than just liability protection.

    0Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    9y

    @Nick Romano conventional mortgages have specific terms that they cannot be held by an LLC. Borrowers know this to be the case, so they take out loans in their personal name, then deed them to an LLC. They don't tell the lender what they are doing because they are trying to get around the terms of their contract. So the borrower knowingly violated the terms of thier contract and didn't disclose it to the mortgage company. In order for this to rise from breach of contract to fraud, it comes down to intent. Did the party knowingly violate the contract for their own personal gain? Yes.

    I am skeptical of the likelihood of a bank actually finding out or taking any action. As long as your mortgage is being paid on time, this will probably go un-noticed. Still they technically could call your loan, so why take this risk.

    The larger question is if this really affords you any protection. It would be easy to pierce the LLC because the property is financed in your personal name. It is hard to claim separation of personal and business in this situation. Obviously you deeded the property to protect the asset from liability and the court can see through that.

    The other thing to consider is who really owns that property. Most of the time on a financed property the bank owns 80%. You are protecting an asset you don't really own.

    Legal entities are very important for people protect people with considerable assets, but the reality is that most starting investors have very little. The majority of people have little to negative net worth.

    Liability insurance is needed protection, but I also advocate properly managing your properties as the best prevention. Respond immediately to any safety concern. Do safety checks on your property to make sure unsafe conditions do not exist. Avoid swimming pools, trampolines and dangerous dog breeds. Make sure icy side walks are sanded and salted. There is still no guarantee, but taking these precautions will limit your risk more than an LLC will protect you.

    1. wrongful or criminal deception intended to result in financial or personal gain.
    5Reply
  • Nick Romano
    OP
    Boston, MA · Member since 2016 · 47 posts · 7 votes
    9y

    @Jeff B. @Edward B. @Jerome Hanson @Joe Splitrock Thanks so much for all the dialogue.  I love the back and forth!  Clearly there is no "black and white" answer here.

    I definitely have a good idea of whats going on with transferring deed now.  Honestly, it seems to all fall in the gray area so its all about personal preference and ability to react.  As long as you're well educated about the consequences and fully understand the contract I think the real answer is:  It's up to you.  

    Awesome chain and thanks everyone for bringing up great points!!  Good work I hope this forum helps people get better educated on transferring deeds.

    Thanks! 

    0Reply
  • Jeff B.
    Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    9y

    I'm sure we are all please with your current understanding  @Edward B., @Jerome Hanson, @Joe Splitrock

    0Reply
  • Ray Jansma
    USA · Member since 2016 · 66 posts · 18 votes
    9y

    I've talked to my loan officer who has done hundreds and hundreds of deals and he said a ton of people do this to get the extra liability under the LLC and I asked him specifically if the mortgage company(his own company) would come after me for the loan balance. He said technically they could but it has never happened with them and 99.9% won't happen in the future. The only thing that may sway lenders to do this is a huge depression that have banks trying to get paid quickly. I can imagine that some banks did this during the 07-08 years when housing bubble burst, but even then I don't think a ton of banks went after the loans that were actually getting paid and were just using a different entity than the ones used under the initial contract. It's no fraud, you have to have intent and/or recklessness to prove fraud. This is a civil contractual issue, not criminal.

    0Reply
  • Jacob Pereira
    Real Estate Agent · Austin, TX · Member since 2014 · 636 posts · 486 votes
    9y

    I think @Satha Palani made an important point that has been glossed over in this thread. Why do you want to transfer the property to your LLC so badly? a $2M umbrella policy costs next to nothing, and unless you plan on being knowingly and exceedingly negligent to the point where your actions kill or maim multiple people, that will cover any liability you may have. If you're looking to buy in a partnership it makes sense, but if it's simply in your name or yours and your spouse's name, I'd recommend against it.

    I know your CPA disagrees with me, and to be fair, he knows a lot more about taxes than I do, but the advantage I have is that I have no vested interest in this and I'm an actual real estate investor (although he may be too. It wasn't stated). If you transfer it into an LLC that's a few more tax documents that he gets to fill out, which equals another few hundred dollars in his pocket. I'm not saying that that necessarily is his motivation, but unless he can give you a valid reason that is based in tax law rather than liability, I would ignore his advice on this one.

    As a side note, I'll give you my interpretation of your initial question; if you intend to quit claim your property right from the start and never inform your bank about it (either before the initial loan, or before or after the quit claim) you are at a minimum being dishonest and violating ethical norms, although I'm not certain that you'd be breaching the contract. I'm also not a lawyer, so take it as advice from some guy on the internet, not as legal fact.

    1Reply
  • Ronald PerichPro Member
    Investor · Granite City, IL · Member since 2014 · 658 posts · 301 votes
    9y

    One reason to use an LLC is if you are going to have both passive and active income real estate businesses. You don't want mix the two or the sale of long term buy and hold could be classified under taxes as active income. So keeping passive property in one corporate structure and active under a different one could be useful.

    http://www.creonline.com/irs-definitions-real-esta...

    1Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    9y

    I bet title insurance and property insurance companies love these back door QCD transfers. If you don't own it anymore, how easy will it be for them not to pay on a claim?   LOL. Asset protection

    1Reply
  • Mike Dymski
    Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    9y

    It will be interesting to see what the banks do if we ever have a rising rate environment and they have a bunch of low rate loans that were transferred and they can invoke the clause.  Not advocating one strategy or the other...that's already covered above and with weekly posts on the subject.

    1Reply
  • Jim KennedyPro Member
    Accountant · Cherry Hill, NJ · Member since 2016 · 173 posts · 201 votes
    9y

    Im a CPA who has worked regularly with hundrds of real estate investors over the past 12 years, but more to the point is I am in investor too, so please consider the following comments as you evaluate your choices.

    1. Maybe others said it, but you cannot sign over the property from personal to LLC with a mortgage in place. technically, yes you are committing mortgage fraud, and if the lender finds out, they have the right to call the whole loan now!

    2. We own a number of residential and commercial properties in Southern NJ and until recently in Texas. Only the commercial ones are/were in an LLC. About a dozen residential are owned personally, with 2 million of umbrella insurance in place. I am not scared. If you train your tenants correctly, focusing on the fact that you are a business and conduct things in a business like fashion, you dramatically decrease the chances of getting sued. At 4PM today I am doing a walk thru with a new tenant. I told him to allows 45 minutes alone, just for reviewing the lease, and he and I will initial every single page of the lease - the lease we purchased from a well knownlocal real estate attorney. And so on

    3. You'll get a better interst rate if you own it peronsally, then in an LLC. Face it, if its in the LLC, and you default, all the bank can get is a property that is likely at that point under water. That mkaes you a biger riskj, which reflects in the interest rate. Own it personally, and they can go after you personally, so you are not as much of a risk. What are the chances of that actually happening? Well, they are much much lower if you train your tenants correctly...charge the late fee ....file for eviction...

    Jim Kennedy CPA

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free