Many first-time investors wonder if they should form a Limited Liability Company (LLC) before beginning their search for an investment property.
After all, nearly every real estate investing seminar, book and podcast mentions the importance of making sure your home and other investments are legally protected by the firewall an LLC creates between you and the party coming after you.
Here’s the problem with creating an LLC before you buy. If you intend to finance your real estate investment with a mortgage, the lender will likely ask to see your LLC’s financials. If you just created your LLC, odds are you don’t have any. And unless you have a long-term relationship with a lender, or large investments elsewhere, you’re likely going to have to finance your first property with a mortgage in your personal name.
Here’s the other problem with banks and an LLC. The bank views any transaction with an LLC to be a commercial transaction, and therefore, financing must be in the form of a commercial loan. While these are often easier to qualify for, they aren’t without challenges. Shorter amortization schedules and slightly higher interest rates are fixed for shorter terms. This may result in less cash flow.
Doesn’t not having an LLC leave you open to legal liability?
While I’m not an attorney, I can tell you what many of my clients have done while they are establishing a track record.
Many investment property owners add a layer of protection to their investing career by obtaining an umbrella insurance policy. This policy provides personal liability insurance above and beyond what more traditional kinds of insurance, like car and homeowners insurance, will cover. It isn’t very expensive, and not only will it help protect your personal assets, but it is also relatively inexpensive, especially when bundled with other policies.
A few months after assuming ownership of the property it may be wise to simply file a quitclaim deed and transfer the name on the property’s title into that of your LLC. You will probably have to pay the county deed tax to transfer the title.
It is important to note transferring title could potentially trigger the due on sale clause in your mortgage. This may result in your lender requiring you to pay them in full as in their eyes, you’ve “sold” the property. You may want to check with your lender and an attorney before moving along this path.
While LLC’s provide important layers of protection, forming one before buying your first property is an expense you may not need to make.