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As many experienced investors know by now, conventional lending institutions have strict lending guidelines that make it near impossible to get a loan with your LLC.
Most LLC’s don’t have enough established credit to make credit purchases solely based on the merits of the LLC. Additionally, banks require quite an extensive history of income that can support loaning to the LLC adding to the difficulty in qualifying.
Starting as a real estate investor
Usually when you first start out as a real estate investor you will find yourself having to personally guarantee the loan in order to get approved. The lender will underwrite your file using your personal credit and income then require you to sign a personal guarantee. If your LLC stops paying the mortgage, the lender can come after your personal assets in most cases this includes foreclosure of the property.
Unfortunately for most investors, especially beginners, the personal guarantee is hard to avoid. At least until you can get your LLC’s credit and income established. So, how do get your LLC in a position to borrow for your real estate investments?
Here are a few suggestions…
- Do you own a paid off property? If you do then you can deed the property over to your LLC. This will give your LLC an asset with which you can now use as collateral for you to secure loans with. Be sure to check with your CPA in regards to certain tax rules that may apply to the transfer.
- Get an EIN Number. As we mentioned above, most lenders will require your personal guarantee. When you give that guarantee use the EIN or your corporate tax number to gain approval under the business name and help you build credit for your LLC.
- Try to establish smaller credit lines under your LLC. Many lenders will allow you to guarantee the line personally while helping your LLC build up credit. Some lenders will even lend based on a percentage of your receivables. This will allow your credit line to grow at the rate your business does.
- Some lenders will accept an investment property as collateral and not require the personal guarantee. The lender will base the approval on the amount of equity and the monthly cash flow of the property and the net operating income. Ultimately, the market is always changing and guidelines do too so always do your research to see what new programs have hit the market.
- Maintain a good relationship with your lenders. Make payments on time and keep an active role in monitoring your LLC’s credit rating.
Overall, keeping an eye on your credit and having open communication with your lenders about how to establish a good credit rating with your LLC is the path to non-recourse loans. With a non-recourse loan you will not have to sign the personal guarantee when a loan is made to your LLC.
Non-Recourse Loan vs. LLC Loan with Personal Guarantee
Let me tell you a story to explain the difference between a non-recourse loan made to your LLC and a loan made to your LLC with a personal guarantee.
Susie and Alice are both real estate investors. Susie is just getting started and has just formed her LLC. Alice has been flipping houses with her LLC for over 10 years. Alice’s LLC has good income and an excellent credit history.
Both investors purchase homes in the Los Angeles area as investment properties. Susie has to sign a personal guarantee to get her loan approved and Alice obtains a non-recourse loan under her LLC.
Two years pass and Susie and Alice fall into a financial hardship. Susie has a father that falls ill and Alice is in a horrible car accident. The financial hardship that both of our investors have experienced cause Susie and Alice to fall behind on payments and both of their investment properties are foreclosed on by their lenders.
With both loans, the properties have been seized by the lenders as the properties were used to secure the loans for each Susie and Alice. After recovering the properties each lender will most likely sell them in order to recover their loan money and any late payments or fees owed.
Are you in a similar position as Alice? or Susie?
With Alice, her property fell into a rut. Because of her accident she was unable to keep up with maintenance and repairs. This triggered numerous issues with tenants that would complain and not pay rent. The constant turn around in renters was stressing her out and since Alice’s medical situation came as her first priority she decided to just let the house go.
When the lender sold her property they could not recover enough money to wipe out her original debt so Alice still owed the bank $125,000. Because Alice did not sign a personal guarantee on her loan the lender was unable to peruse Alice’s personal assets in order to recover their funds. Her home, her card and other businesses that she owned were safe.
In Susie’s case, while she was helping her sick father get through his medical issue the property had become distressed due to a bad tenant who had not paid rent and left the home in bad condition.
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The lender was not able to recover all the money that Susie had originally borrowed so Susie was now $75,000 in the hole to the lender. Because Susie signed a personal guarantee at the time of her loan she was now personally on the hook for that additional $75,000. The lender was able to sue Susie in court and obtain a judgment against her for the remaining amount owed. Susie was forced to sell her personal residence in order to pay off the remaining balance to the lender.
Summary & Synopsis
In the story above we see that the difference between a non-recourse loan and a recourse loan lies with money still owed after the lender forecloses. In a recourse loan the lender was able to come after Susie and her personal assets to pay off her remaining $75,000 loan balance. They can have her wages/salary garnished or come after other property she may own personally.
With Alice, she was able to qualify for a non-recourse loan and the lender was forced to take the hit on the negative $125,000 that was left on her loan.
One key lesson to the story of Alice and Susie is that having an LLC really doesn’t help you borrow money to invest in real estate. Owning a property with your LLC is about protecting assets from liability pertaining to lawsuits.
If, for example, you own a rental property in your personal name, and someone hurts themselves on your property they could sue you and your personal assets could be at risk. This is why most investors choose to hold their investment properties under their LLC’s.
In closing, holding your real estate properties under your LLC won’t help you get your loan funded but it can protect you from other liability issues associated with being a landlord.
Yes, having an LLC may cause you to pay more annual license fees and extra tax work at the end of the year but ultimately it becomes an advantage after you build up your LLC so that you can qualify for non-recourse loan programs and the added personal protection from civil lawsuits may just be worth it.