The mortgage application procedure is likely to be a little more difficult than usual if you’re a Canadian business owner looking to purchase a house. Due diligence will be required more from lenders, but that’s just part of being self-employed. The good news is that this article will assist you in avoiding typical mistakes that other prospective homeowners fail to notice.
Being able to think like a lender is essential to writing a strong mortgage application. Things that frighten and inspire them. Thus, “risk” is the one term that best captures what matters to a lender. They can provide you a more appealing interest rate if you can present them with a low-risk opportunity.
Simply put, you can get a mortgage in your LLC’s name. However, you need to evaluate your situation to determine if this is really the best course of action. One business owner, for example, decided to look into getting a mortgage for his LLC only to find the options for doing so are limited. Specifically, obtaining a loan with a low interest rate is not an option that is available for most limited liability companies.
This business owner could have easily obtained a mortgage using his company’s name if he were planning to pay in cash. However, like most other small business owners, he didn’t have the means to pay for the property in which he was interested upfront. Instead, he chose to purchase the property in his own name. He did so by making use of traditional financing options and putting an insurance policy in place to protect him if things went south. He made the decision to purchase in this way because conventional loans are the least expensive way for business owners to obtain rental property.
Traditional loans are ideal for this because they have:
- The lowest available rates under most circumstances
- Lower required down payments
- Long-term, fixed financing rates
Loans of this nature have these characteristics because the federal government supports them and they can be sold to government-sponsored mortgage companies such as:
- Fannie Mae
- Freddie Mac
Traditional loans are good options. However, they cannot be awarded to an LLC. They can only be obtained by a:
- Living trust
Pros of Using an LLC to Get a Mortgage
Below are the benefits of using an LLC to get a mortgage:
- Member protections: As mentioned above, owners of the LLC will not be held personally liable if the mortgage goes into default unless there’s a personal guarantee.
- Enhanced privacy: The LLC owner’s names will not be disclosed on mortgage documents that are filed with the county in which the property is located. This also means ownership information will not be accessible to the general public. This is particularly beneficial for celebrities or well-known high-net-worth individuals who would prefer to keep their real estate acquisitions through businesses they own out of the public eye.
- Streamlined investing: You have the option to create a multi-member LLC with others to purchase investment properties. And additional members can be added at a later date by buying shares belonging to existing members.
- Separation of assets: If the LLC is used to get a mortgage, it allows the member(s) to separate personal and business assets.
Cons of Using an LLC to Get a Mortgage
There are also drawbacks to keep in mind before applying:
- Challenging process: Many lenders are hesitant about extending mortgages to LLCs due to the elevated risk of default since members aren’t personally liable. They understand that if the LLC falls behind on loan payments, its members cannot be held personally liable for the debt unless they provide a personal guarantee.
- Limited funding options: Traditional mortgage products, like conventional and government-backed home loans (i.e., FHA loans, USDA loans and VA loans), aren’t available to LLCs looking to acquire properties.
- Steeper borrowing costs: The lender may charge a higher interest rate and steeper fees to offset the risk posed by lending to the LLC. Furthermore, you’ll have to pay fees to establish the LLC in your state if you haven’t yet launched your business, along with annual filing fees to keep it active. You’ll also pay more for tax preparation each year when it’s time to file the company’s returns.
- Forfeiture of special capital gains treatment: When it’s time to sell the property, the LLC won’t qualify for preferential treatment if it’s used as your primary residence.
Also, be mindful that providing a personal guarantee when buying a house with an LLC means your personal assets will be at risk of seizure if the loan becomes delinquent. This approach is sometimes required by lenders or encouraged to access more competitive mortgage terms, including lower interest rates, to minimize borrowing costs.
What do you typically need?
It varies by lender, but expect to bring a down payment of at least 25 percent to the table. Since these loans are riskier than traditional mortgages, a heftier down payment helps minimize potential losses if the LLC defaults on the loan agreement.
If you don’t have this amount available, you may be eligible for a loan program that lets you use assets or personal and business bank statements to qualify for funding. In addition, some lenders feature loan programs that allow you to use the projected income from the property you’re planning to purchase to qualify for funding.
Read Also: Which Business is Best For The Future?
You should also be prepared to provide the following information and documents to the lender:
- Articles of organization and current status from the Secretary of State
- Operating Agreement (if you have one handy)
- Employer Identification Number (EIN) from the Internal Revenue Service (IRS)
- Company bank statements for the past six to 12 months
- Financial documents (i.e., profit and loss statements) and any documentation related to the company’s rental properties (if applicable)
- Financial data (i.e., earnings, outstanding debt obligations) for each member of the LLC
Below are some of the risks:
- Problem: Most lenders require at least a two-year track record for businesses. They’ve been known to make exceptions for professionals like doctors and engineers, as well as people starting a new business in an industry where they’ve already had a long career.
- Solution: If you’ve been in the same industry for many years, start a pre-approval and get the lender to confirm they’ll accept your income. If not, just wait until you’ve filed taxes for two years before you try to buy a home.
- Problem: The more you write off, the lower your taxable income. Fantastic for tax planning, but you’ll need to prove that this income should be counted in your application.
- Solution: Some lenders offer a ‘stated income’ program, meaning they’ll look at revenues and expenses instead of tax returns to try and get a more realistic assessment of your income. Sometimes those estimates are still too conservative, and you might be better off writing off fewer expenses for two years to demonstrate a higher income. Speak with your tax accountant if you think that’s a good option.
Weak Cash Reserves
- Problem: You need to be able to demonstrate that even after a down payment, you have cash in hand to cover unforeseen expenses.
- Solution: Build up as much cash as possible leading up to buying a house. If you have the option, you’ll want to opt for a smaller down payment and keep more cash in your savings. Remember, most lenders offer generous pre-payment benefits, so you have the option to apply a lot of cash directly toward the mortgage down the road.
- Problem: Lenders want to see either a consistent income or a growing income, and will typically take the most conservative estimates. If for example in 2017 you earned $30,000 and 2018 you earned $130,000, they’ll take a blended average to estimate your buying power. If the reverse is true, where 2017 you earn $130,000 and 2018 earn $30,000, they’ll take the most recent year as your income.
- Solution: Keep this in mind when dealing with your accountant.
To be completely frank, the documentation requirements for business owners can feel pretty heavy. But, if you keep clean records, you should be able to collect them quite quickly. Here’s a quick list of what you’ll need to provide:
- Two years of financial statements prepared by an accountant (only if you’re incorporated)
- Documents detailing your year of incorporation
- 2 years of T1 generals for your personal and business returns
- Bank statements illustrating current cash flow and incoming income
- Your past notices of assessment for at least two years
Keep in mind, that that’s a list of likely documents, but it’s by no means exhaustive. You’ll almost certainly be asked for more, so make sure you consult with your mortgage broker or banker early.
Even if you aren’t ready to buy right away, it can take time to prepare and build a strong. By taking the time to keep detailed documents, you can set yourself up for success and save a ton of money in the process.
Where Can an LLC Get a Mortgage?
Mortgages for LLCs are available through conventional lenders, portfolio lenders, local community banks, and private lenders.
- Conventional Mortgage Loans for LLCs
These include traditional banks and credit unions. You’ll generally find competitive rates through these lenders, but you’ll have to do quite a bit of legwork to find entities that are willing to lend to you on behalf of your LLC.
- Portfolio Lenders
Portfolio lenders manage their own loans instead of selling them off once they close. As a result, they tend to be more flexible than conventional lenders.
- Local Community Banks
Like portfolio lenders, local community banks also retain ownership of their loans to LLCs after closing. However, they, too, have flexible eligibility and funding criteria.
- Private Lenders
Private lenders, like Angel Oak Mortgage Solutions, are a great place to start when scoping out mortgage options for your LLC. This particular lender is full-service and offers several innovative financing solutions to meet your needs. These include bank statement home loans, jumbo home loans, investor cash flow loans, asset qualifier loans, portfolio select home loans and conventional home loans. Government-backed mortgage products, including Federal Housing Administration (FHA) loans, USDA loans and VA loans, are also available through Angel Oak Mortgage Solutions.
The option LLC owners find most useful is the Investor Cash Flow Mortgage. It’s designed for real estate investors who want to expand their portfolios of income-generating properties without having to provide traditional income documentation, like pay stubs, W2s and tax returns. Plus, proof of employment and complex income statements aren’t required. Instead, the loan amount is determined by the earning potential of the property.
You could be eligible for a mortgage between $75,000 and $1.5 million that can be placed in the LLCs name if you already own a home that’s used as your primary residence. Some additional perks to consider:
- This loan can be used to purchase an investment property, complete a rate-term or pull out equity through a cash-out refinance.
- There’s no limit on the number of properties you can acquire in some instances. (Note: Angel Oak Mortgage Solutions may have limitations on the number of homes in your portfolio that can be financed).
- You’re permitted to buy non-warrantable condos and short-term rentals with loan proceeds.
- You may be able to acquire short-term rentals, like VRBOs and Airbnbs, through this loan program.
A mortgage is a loan toward the cost of a property. The business must use the property for wholly business purposes.
A business can use a mortgage to:
- Acquire a property.
- Refinance a property (to replace an existing mortgage, or to cash out a portion of equity).
- Redevelop a property.
Many people also ask “can a business get a residential mortgage?”. The answer is yes, as long as you use the residential property for commercial purposes. So if you want to borrow toward the cost of an apartment complex with the view to generate rental income, a commercial mortgage is a suitable option.
If you want to borrow through your business to finance the purchase of your personal home, however, this is not possible.
A business mortgage can deliver several benefits to your business:
- At the end of the mortgage period, your business will own the property.
- While paying off the mortgage, you’ll be working toward ownership, rather than putting your money in a landlord’s pockets.
- The total spent on mortgage interest will be lower than what you’d have spent on rent in an equivalent period.
- You can release equity from the mortgage when required by refinancing.
- The property may increase in value. In this instance, the value of your investment increases as well. When renting, this increase in property value would lead to higher repayments, disadvantaging you and benefiting the landlord.
- Financial forecasting becomes more simple with a mortgage because repayments are less prone to variation than rent.
Also, interest rates are usually lower on commercial mortgages than other types of business finance, thanks to the high value of the property the loan is secured against.