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Should You Use an LLC to Get a Rental Property Mortgage?

by Jeff Rohde, posted in Investment Strategy

When you own rental property, it’s usually a good idea to hold it in the name of an LLC, to help limit your liability and build credit for your real estate business. However, it can be tricky to obtain an LLC mortgage, especially if you’re doing it for the very first time.

Here’s how mortgages for an LLC work, the pros and cons of having a property loan under your LLC, and where to look for an LLC mortgage.

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What is an LLC?

An LLC – or limited liability company – is a business structure owned by one or more individuals or entities. 

LLCs do not pay taxes on the corporate level the way that C corporations do. Instead, LLCs are ‘pass through’ entities, which means that net profits or losses are passed through directly to each LLC member, reported on Schedule D of Form 1040, and taxed at the individual’s rate. 

One person can create a single-member LLC or an LLC can have multiple members, such as a joint venture formed for the purpose of investing in rental real estate. LLCs are formed at the state level, so the way an LLC is formed will vary from state to state. 

If you’re curious about how to form an LLC in your state, the legal resource website has put together a 50-State Guide to Forming an LLC.


Benefits of Owning Rental Property with an LLC

There are several benefits to owning an investment property under an LLC instead of in your personal name:

Limited Personal Liability

An LLC can limit your legal liability to only the assets held under the LLC. For example, if you are ever involved in a lawsuit with a tenant or vendor and have a judgment against you, the assets at risk are limited to those held by the LLC. However, there are some exceptions to the protection an LLC offers, such as when an investor commits outright fraud.

Partnership Investing

LLCs make partnership investing much easier because the LLC is the entity that owns the real property. 

Each member of the LLC can have different ownership percentages, or even different shares of the profits and losses, depending on how the LLC operating agreement is written. 

Pass-Through Income or Losses

Income and losses in an LLC are passed through directly to the owners, who then pay tax based on the individual tax bracket they are in. 

By comparison, a C corporation pays taxes at the corporate level while shareholders also pay taxes at the individual level.

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Increased Privacy

LLCs also help to make property ownership more anonymous. 

When property is held in the name of the LLC and investors use a property management company to handle the daily operations, tenants and vendors won’t know the names of the individuals who actually own the real estate.

Keep Rental Properties Separate

It’s a good idea to form a separate LLC for each rental property that you own. In addition to keeping your personal and business assets separated, you can also keep your individual business assets separated from one another. 

That way, if there is a lawsuit involving one of your properties, the other properties as well as your personal assets will be protected.

Avoid Commingling Business and Personal Expenses

Having investment property in an LLC also makes it much easier to avoid accidentally mixing personal expenses with business expenses, something that the IRS will usually look for if you’re ever audited. 

Your LLC will have its own bank, debit, and credit card accounts. Then, all you need to do is connect those accounts with your Stessa rental property financial management software to automate income and expense tracking and monitor property financial performance from your owner dashboard.


Options for an LLC Mortgage

Mortgage lenders may make it difficult for you to get a mortgage under your LLC for the exact same reason you form an LLC – protecting your personal assets. 

Unless you’re an experienced real estate investor with a track record of success, the bank will probably ask you to personally guarantee the loan. That means that in addition to looking at your rental property financial statements and rent roll, a lender will also review your personal credit history and assets.

With those caveats in mind, let’s look at what documents to put together and the options for an LLC mortgage.

Application Documents for an LLC Mortgage

If you haven’t done so already, you’ll need to form and register your LLC with your state’s Corporation Commission or Secretary of State’s office. You should also have an operating agreement for your LLC, especially if you will have investment partners.

You’ll also need an employer identification number (EIN) for your LLC which you can get from the IRS online. Lastly, you’ll want a business checking account for your LLC, along with a debit and credit card.

The lender will want this information, along with some basic information about yourself, such as personal income, assets and debts; a mortgage loan application, and a list of your other rental properties (if you have others).

Using financial rental property management software from Stessa makes it much easier to provide a lender with the information they need. You can generate income statements, net cash flow reporters, and capital expense ledgers at both a property and portfolio level, and also export tax-ready financials.

Conventional Mortgage

A conventional mortgage for an LLC can offer the best terms, interest rates, and down payments. But the lender will likely want your personal guarantee, along with a credit report and personal financial information. 

While there are some drawbacks to guaranteeing the loan, it’s a good way to begin building credit for your LLC, especially if it is brand new.

Savings & Loans and Community Banks

Local banks and savings and loans in the market your rental property is located in are also excellent options for getting a mortgage with your LLC. 

Because smaller lenders like these are more community-focused, they may be more willing to work with you since you’re providing needed rental housing in the market.

Portfolio Lenders

Portfolio lenders are more creative in structuring an LLC mortgage with terms and conditions that meet your investment goals. They tend to fund faster than conventional lenders and smaller banks, but fees and interest rates may be higher. 

Lenders like these can be a good first option to obtain an LLC loan, since you can always refinance for better terms at a later date.

Private Lenders

Private lenders are a good match for rental property investors looking for short-term financing, such as a property that needs a lot of renovations before it can be rented to a tenant. 

Down payments, fees, and interest rates are usually higher, and the private lender may want to cross collateralize the loan with your other assets. On the plus side, private lenders can be very innovative with devising a mortgage that fits the needs of your LLC.

Recourse vs. Non-Recourse Loans

Two terms to understand when you are looking for an LLC mortgage are recourse and non-recourse loans. 

As the names suggest, a recourse mortgage gives the lender the right to go after your other assets if the loan defaults, even if the mortgage is held in the name of your LLC. On other hand, a non-recourse loan limits your liability to the rental property securing the loan.

Build a credit line for your LLC

Although you’ll need to jump through a lot of hoops to obtain your first LLC mortgage, it may well be worth the extra effort. 

By building a credit line for your LLC with your first loan, the process for getting additional loans under LLCs controlled by you will become easier each time you add an additional rental property to your portfolio. 

Eventually, you’ll reach the point where a lender will look at your success as a real estate investor and the cash flow being generated by your investments, rather than your personal financial situation.


Pros and Cons of an LLC Mortgage

Here’s a quick summary of the pros and cons of having an LLC mortgage for your rental property:

Pros of having an LLC mortgage

  • Limited liability and increased protection of your business and personal assets.
  • Limiting exposure acts as a type of liability insurance in a worst-case financial catastrophe.
  • Builds a business payment and credit history for your LLC.
  • LLCs are easy to set up and register online at your state Corporation Commission or Secretary of State’s office.
  • Pass-through taxation to your individual tax return avoids paying additional tax at the corporate level.

Cons of having an LLC mortgage

  • Lenders may require real estate investors to provide a personal guarantee if they are applying for an LLC mortgage for the very first time.
  • If the LLC is unable to pay the mortgage, the personal guarantor’s assets may be at risk if the bank forecloses on the loan.
  • Most states charge an annual renewal fee to keep an LLC active and in good standing, although the benefits of having an LLC are worth an extra few dollars each year.


Wrapping Up

Getting an LLC mortgage for your rental property will require some work, but it isn’t as hard as many investors think. After forming your LLC and identifying a rental property to purchase, shop around for lenders who are willing to work with real estate investors. 

Oftentimes smaller community banks are more receptive to originating an LLC mortgage since you’ll be providing needed rental housing to the local community. 

Stessa can help to speed up the process when the time comes to apply for your LLC mortgage. Using a free rental property financial management software system from Stessa simplifies the process of generating real-time performance reports of your rental property that every bank will want to see.

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