Liability for Loan Defaults Under LLCs
Here’s a question too few new real estate investors ask:
“If I default on the LLC’s mortgage, can the lender come after me personally?”
In most cases the answer is yes.
When you borrow a mortgage on an LLC-owned rental property, the lender typically requires you to sign a personal guarantee. The document says that although the LLC is the borrower of the loan, you personally guarantee the payments and therefore become personally liable to them.
So if you default, the lender may come after you personally.
In practice, personal liability looks like this: You default on the LLC rental mortgage, and the lender forecloses. If the property in the foreclosure auction doesn’t raise enough to cover your balance, the lender will then file a personal judgment against you.
That judgment often attaches itself to your house and car, and the lender can even seize your wages if he wants to. It’s ugly.
The moral of the story? Don’t think you can’t pay the loan if you default just because the loan is under an LLC and not your personal name.
Before Applying for a Mortgage for a Rental Property LLC:
Before you call a mortgage lender and ask for $200,000, get a few ducks in a row.
First, you create the business entity by registering it with your state’s Department of Labor and Licensing, or the Department of Assessments and Taxes. These departments have slightly different names in each state, but a quick Google search should clarify.
And don’t waste $2,000 on a lawyer filing this for you. Unlike most bureaucratic processes, this one is designed to be easy (it’s better to burden yourself with it, my dear). All you need to do is get a template copy of LLC articles of organization for your state, fill in the blanks, and submit it to your state’s department. Together with the file costs of course!
You must also have an Employer Identification Number (EIN). If you don’t have one yet, you can get an EIN online from the IRS directly here.
Ideally, you should also have a business checking account set up for your LLC. Local community banks and online banks often offer these for free, hint hint.
The lender may also ask you for a copy of your LLC’s operating agreement when you apply for an LLC mortgage for rental properties. These don’t have to be complicated – the most important part in the operating agreement is the list of LLC owners and their percentage of ownership. Business agreement templates can be found cheaply or for free online.
Further, of course, the lender will require all the usual from you: a loan application, income documentation (if you are using a conventional lender rather than a portfolio lender), a list of your existing rental properties (if any), and so on.
Don’t forget to keep a money pillow
Many new investors fixate on the down payment and forget about the other fees that require cash.
When you borrow a mortgage for an LLC rental home, you better believe that you will have closing costs. The origination cost of the lender alone often comes in at 2-5 points! (A “point” is a fee equal to 1% of the loan amount.)
Which says nothing about the lender’s junk fees, such as “administration fees” and “processing fees” and “we’re making fun of you because-we-can-fee.” And then you have ownership and settlement costs, insurance premiums, property taxes that are due up front, and many other closing costs.
Granted, you can (and should) negotiate a concession from the seller to reduce your money needed for closing costs. But brace yourself for a raging frenzy at settlement.
Many lenders also require cash reserves for at least six months’ mortgage payment. Even if they don’t need it, set aside a healthy cushion of money for unexpected landlord expenses such as vacancy, repairs, maintenance, and so on.
You never know when the oven will fail and need to be replaced!
Setting up an LLC and getting a mortgage for an LLC-owned rental property is not as difficult as it may seem at first. But be prepared to talk to half a dozen lenders before you find the right fit.
Basically, think of rental housing financing options as a set of tools in your toolkit. You don’t just need a hammer; you will also need several screwdrivers, a drill, wrenches, and so on. The same goes for lenders – you need multiple options, especially for different markets or different types of real estate deals.
But as you build your toolkit, you’ll discover that all investor-focused lenders can provide LLC rental home mortgages and may even be able to purchase rental properties under a self-directed IRA.
Finally, keep in mind that investment property lenders focus on your deal, not just you personally. When you find great deals on real estate investments, you will have no problem financing them. And the reverse is also true: no lender in the world will touch an unattractive deal.♦
How did you finance your rental properties? What’s your favorite go-to source for rental LLC mortgages?