When faced with this dilemma, many real estate investors have elected to try and have it both ways: First close with a Fannie Mae loan, then change title over to an LLC after closing… and cross their fingers.
Good news for investors from Fannie Mae
If you’re among the large number of real estate investors who’ve chosen to roll the dice, your finger-crossing days may be over. In November (quietly and with no fanfare) Fannie Mae announced that they now allow the post-closing transfer of title to an LLC.
Vesting and due-on-sale clause
The heart of the dilemma investors have faced stems from the ownership (or “vesting”) Fannie Mae allows and the “due-on-sale” clause found in the promissory note every borrower signs at closing.
At closing, Fannie Mae allows only living, breathing people or inter vivos revocable trusts (the “living” estate-planning kind) to take title. After closing, it’s easy to transfer title — just sign a deed and pay a nominal recording fee to the county and you’re done. However, transferring title triggers a “due-on-sale” clause buried in those papers you signed at closing.
It goes like this:
“If all or any part of the Property or any Interest in the Property is sold or transferred without Lender’s prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument.”
“If Lender exercises this option, Lender shall give Borrower notice of acceleration. The notice shall provide a period of not less than 30 days from the date the notice is given… within which Borrower must pay all sums secured by this Security Instrument. If Borrower fails to pay these sums prior to the expiration of this period, Lender may invoke any remedies permitted by this Security Instrument without further notice or demand on Borrower.”
In a nutshell: Transfer title and your loan comes due, in full. Get caught transferring title and you have 30 days to pay up or your loan will go into foreclosure.
Liability protection with an LLC
Despite this scary language, the majority of real estate investors I know (including yours truly) choose to roll the dice and transfer title to an LLC anyway. Unlike investing in stocks and bonds, investing in real estate has an inherent element of risk. When an accident happens at a rental property the owner is at risk of being sued, personally. Even with good insurance, a sizeable enough mishap and you may lose not just the rental property itself, but even your other assets — including your home.
A properly formed and maintained LLC can act as a firewall between the property and the owner, limiting the risk of loss to just the assets owned by the LLC itself. If something terrible happens at your rental property, you may lose the property and its bank account, but you shouldn’t lose your home, other savings or (assuming they are in different LLCs) other rentals.
LLC financing is possible… but can be costly
It is possible to finance a rental property and put title in the name of an LLC at closing. Doing so offers the protection of an LLC with no risk connected to violating a due-on-sale close.
At the moment, we work with five different investors that allow a borrower to take title in the name of an LLC at closing. And these programs offer some other benefits, such as leeway to finance more than the 10 properties Fannie Mae allows and/or use non-traditional income documentation.
But there is a catch: the financial terms offered on these loans are generally less favorable than those offered by Fannie Mae. The down payment required and rates available are generally higher. And most of these programs are only offered as adjustable rate mortgages.
Pick your poison
When forced to choose between the day-to-day risk connected to whatever mishap may befall a drunk tenant this weekend versus the nebulous risk that your loan servicer may notice a title transfer or less favorable loan terms, it’s no wonder that so many real estate investors choose the loan they prefer, and then take their chances with a title transfer to their LLC.
Foreshadowing
To me, this guideline change was a pleasant surprise, but not entirely out of left field. Fannie Mae, for many years, has salted their guidelines with evidence they’re well aware post-closing title transfers are a common practice.
For instance, under Fannie Mae rules you must own a property for six months before you are eligible take out a cash-back refinance — but ownership in an LLC that holds title, counts toward this required six months. Additionally, Fannie Mae has “delayed financing” rules that allow an immediate (no waiting period) cash-back refinance of a property purchased for cash. Properties purchased in the name of an LLC that is 100% owned by the borrower (or borrowers) are eligible for this exception.
With hints like this, I’ve long suspected that maybe (just maybe) Fannie Mae didn’t really mind transfers to an LLC.
The fine print
To take advantage of this new leniency, there are some rules to follow:
• Your mortgage must have been purchased or securitized by Fannie Mae on or after June 1, 2016. You can look up whether your loan is owned by Fannie Mae and when it was purchased on this handy site.
• The LLC must be controlled by the original borrower on the loan or the original borrower must own a majority interest in the LLC.
• And if the title transfer happens as you convert a residence (primary or secondary) to a rental, the timing can’t violate any other terms of your loan (for example the requirement to live in a property for 12 months after buying it as a primary residence).
• And your servicer will be required to notify you that you’ll be required to transfer title back to your own name before refinancing it in the future.
ADUs and AirBnB and vacation rentals
As I was writing this post, it occurred to me that there are good reasons to consider putting a primary residence or second home into an LLC. If you rent out an ADU or host guests through AirBnB or rent out a vacation home sometimes (or even let friends use it), a little liability protection may be in order.
LLCs and tax filing
If you chose to transfer title to an LLC, you may complicate your tax filing. An LLC that is owned by just one person is considered a “disregarded entity” by the IRS. You can go about filing your taxes like you normally would and pretend the LLC doesn’t exist.
As soon as an LLC has more than one owner (be it a person or another entity), then the LLC must file its own income tax return. Most LLCs that own real estate seem to file taxes as a Partnership. I suggest getting some advice from a qualified tax professional (and I would be happy to recommend one) before transferring title to an LLC.
Fannie Mae but not Freddie Mac, FHA or VA
It’s important to note that this change only applies to loans purchased or securitized by Fannie Mae. If you finance a rental property with a Freddie Mac loan program, or you convert a residence you purchased using an FHA or VA loan, a title transfer to an LLC still triggers the due-on-sale clause.
It’s all about the servicing
And although Fannie Mae is okay with a post-closing title transfer, whether or not you can take advantage of Fannie Mae’s generosity still depends on your loan servicer. Before transferring title, you must contact your loan servicer and request permission.
As a fellow real estate investor, I love working with like-minded clients. If you’re looking to purchase or refinance a rental and you’d like to transfer your title to an LLC after closing, please reach out. I will work with you to make sure your loan is directed to a servicer who will allow you to take advantage of this exciting new development.
Call 503-799-3711 or email juleef@rate.com. I look forward to hearing from you!
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