Most real estate investors, even newcomers, know that they ought to hold their rental properties in the name of an LLC or other limited liability entity. However, many aspiring investors are surprised by how difficult it can be to finance a rental property in the name of an LLC. If this is the best practice, why is a mortgage lender putting up hurdles to you actually doing it?
In this article, we will discover one of the most straightforward paths to finance rental property within an LLC — DSCR loans plus business credit. We will also touch on why LLCs are so important to real estate investors, and how Munoz Ghezlan Capital has helped hundreds of real estate strike the perfect balance between leverage and limited liability.
Key Takeaways:
- LLCs are a form of business entity that limit your liability to the assets held by the LLC, protecting your personal assets and other businesses from judgments. They are also easy to transfer, sell, and mine for tax advantages.
- Traditional mortgages cannot legally be put in the name of an LLC, but other forms of financing — like DSCR loans and business credit — can and actually prefer to lend to LLCs instead of individuals.
- DSCR loans are a kind of investment mortgage based on the income potential of the property, not personal income and debt. Business credit, such as an unsecured working capital loan, is a kind of business loan that can be used for many real estate operational expenses.
- Securing business credit for real estate under an LLC will require you to have a business bank account in the name of the LLC and turn over critical LLC documents to the lender, including the articles of formation, operating agreement, certificate of good standing, and proof of signing authority.
- Special considerations apply to using business credit as a down payment for a DSCR loan under LLC ownership, including disclosure of the source of funds, lender approval, and seasoning requirements. Investors stacking debt should also beware of overleverage.
Why Serious Investors Buy Rentals Through LLCs
Before we discuss why investors should consider financing their rental acquisitions with a DSCR loan under LLC ownership, let’s revisit why so many real estate investors prefer this entity to hold their investments.
“LLC” is short for “limited liability company.” As the name suggests, the purpose is to limit the business liability of the owner.
Every business has its liabilities for the owner, and with rental property investing these liabilities are arguably some of the most pronounced. A landlord could face liability for:
- Tenant injuries
- Contractor disputes
- Habitability claims
- Fair Housing allegations
Any of these disputes could result in a lawsuit. If that happens, who owns the property becomes a key factor, because whoever owns the property is who gets sued.
Most homeowners take title to their primary residence in their own personal name (or jointly in the name of two spouses). Nothing is preventing you from doing the same with your rental property.
However, in the event that a tenant decides to sue the landlord, the landlord is you. If the tenant wins a judgment, all of your personal assets are at risk of being attached in that judgment — your personal residence, other rental properties, your car, your bank account, your retirement account or other assets. All of them are vulnerable when you own rental property in your own name.
An LLC is not you, even if you are the sole owner and member. Legally, it is an entity separate from you. It may not have an office headquarters (though one day it may), but it legally speaking is a real company, filing taxes and establishing an on-paper existence separate from you, even though you may have founded it.
If your LLC owns the property instead of you personally, only the assets owned by the LLC can be targeted in a lawsuit. This may be nothing more than the property itself, any property operating accounts or reserve accounts, and associated assets. Your personal residence, personal property, and other assets can not be targeted, because the LLC does not own them.
Real estate investors with a portfolio of properties usually create a new LLC for each property so a problem with one building doesn’t put another building at risk. Each property is a separate legal entity, liable only to that individual property
Why an LLC and Not Some Other Entity?
We most commonly hear about an LLC as the entity of choice for real estate investors. However, LLCs are not the only entities that limit personal liability. Corporations, trusts, and limited partnerships also provide liability shields — and some investors prefer them.
However, LLCs are the go-to for a variety of reasons:
- Fast and affordable to set up.
- Similar tax advantages to corporations.
- Less compliance burden than corporations (required officers, mandatory annual meetings, keeping of meeting minutes, etc.)
- Less case law governing their operations, since they are newer on the scene than corporations, trusts, or limited partnerships.
The LLC as the Foundation of Rental Property Ownership
An LLC acts as the “operating container” of the individual investment. It owns the asset, signs lease agreements as the lessor, collects rent, and pays expenses.
As the LLC owner, it may be your hands writing and cashing the checks, but in the eyes of the law, the LLC is doing all of this. You are merely acting on authority and permission granted to you by the LLC operating agreement (even if you’re the one writing the operating agreement and effectively giving yourself the authority).
This helps investors keep different investments separate as they scale their portfolio, with no commingling of funds or cross-contamination of books, which may make taxation and compliance more difficult.
Components of an LLC
What brings an LLC into existence anyway? What maintains its existence? The core components of an LLC include:
Formation Documents. The official documents that bring an LLC into being are the Articles of Organization, filed with and approved by the Secretary of State of the state in which it was founded.
Operating Agreement. This document states who owns the LLC, what fraction of ownership they have, what roles they play in the management of the LLC, who can sign checks and contracts, and whether the LLC will be managed by “members” (owners or co-owners of the LLC) or “managers” (officials appointed by the members).
Employer Identification Number (EIN). This is the “Social Security Number” of the LLC — its tax ID number, issued by the IRS upon formation of the LLC so it can report income, file taxes, and open bank accounts.
Business Bank Account. You can have an LLC without a bank account, but where else will you deposit rent checks and draw funds to pay expenses? If you use a personal bank account or the account of another company, you risk losing the liability protection of the LLC because you are treating it as a commingled entity. Therefore, nearly every LLC owner avails themselves of the right to open a business bank account in the name of the LLC.
What an LLC Actually Does in Real Estate (Beyond “Liability Protection”)
In addition to shielding the owner from personal liability, an LLC serves the following functions within a real estate investment:
- Contracting Authority. The LLC signs vendor agreements, property management agreements, utility contracts, leases, etc. Yes, a fictitious business entity does not have hands to sign, but the owner or managing member is given authority by the operating agreement to perform these actions on behalf of the LLC.
- Banking and Bookkeeping Clarity. By keeping separate books and bank accounts in the name of the LLC, a real estate investor can keep operating income and expenses separate from personal income and expenses, as well as income and expenses from other companies or LLCs. This helps keep the books clean and avoid loss of liability protection due to commingling.
- Ownership Flexibility. Compared to corporations, it is relatively easy to add members, allocate profits, create ownership interests, and restructure management in an LLC.
- Estate and Continuity Benefits. It is easier to will or transfer ownership of an LLC without operational interruption than it is to will or transfer ownership of property held in a personal name. (Not tax or estate-planning advice — consult a CPA, estate planning attorney, or tax advisor for more concrete advice.)
Why Investors Choose LLC Property Financing Instead of Personal Ownership
Real estate investors choose LLC property financing over personal ownership for a variety of reasons, including:
- Privacy and Professionalism. In addition to presenting a professional face for their rental units, LLCs provide investors with some degree of privacy, since the owner of public record is the LLC, not the investor by name. Different states offer different levels of privacy for LLC owners, but all states offer at least some insulation for the investor’s personal name.
- Repeatability. For real estate investors with ambition to grow their portfolio, the LLC becomes a valuable tool because it establishes a reusable process that can be replicated from property to property. (Formation documents, operating agreements, boilerplate contracts, etc.)
- Exit Options. A real estate investor wishing to exit an investment need not necessarily go to the trouble of selling the property. Instead, (s)he could potentially sell some or all of the interest in the LLC. Since the LLC is the actual owner of the property, control of the property effectively transfers with the LLC.
- Tax Advantages. LLC owners can deduct nearly every expense associated with the property, along with other real estate-only deductions like depreciation expense and the “pass-through” deduction. Because an LLC is a “pass-through” entity — meaning deductions pass through the entity to the owner(s), those expense deductions can be applied to the owner’s personal tax return.
Common LLC Structures Used for Rentals
Single LLC with Multiple Properties
There’s no rule that an LLC can only own property. As an individual legal entity, it can own as much property as it can legally acquire. This makes bookkeeping, record-keeping, and taxes simple and inexpensive — only one tax return to file, all income and expenses flowing into and out of one bank account.
The obvious downside of this structure is liability — if one property owned by the LLC gets sued, the other properties owned by the LLC could be attached in any judgment against that LLC.
One LLC Per Property
Much more common than holding multiple properties in the name of one LLC is to hold each property in its own separate LLC. This protects each property from liability for the others — if one property gets sued, only that property is exposed because the other properties are owned by a different entity, legally completely separate even if the LLCs have the same owner.
However, multiple LLCs means multiplication of paperwork — separate formation documents, operating agreements, bank accounts, and tax returns for each. Each new LLC incurs new filing fees, and the owner must file a separate tax return for each LLC. If the owner hires a CPA or tax preparer, tax preparation costs for all those LLCs can add up.
Holding Company + Property-Level LLCs
Some real estate investors choose not only to hold each property in a separate LLC, but to establish a “parent” LLC that owns all the other LLCs. This may help the owner of a large portfolio establish centralized operations while preserving separation between each asset. However, strict siloing must be maintained to prevent a liability for one property from threatening the others.
Series LLC (where available)
Not every state offers “series LLCs,” but they are a popular option for real estate investors who can access them. They essentially allow the former to create one LLC with several “series” within the LLC. The LLC can hold multiple properties, but each one is held as a separate “series,” and each series enjoys liability protection from the other.
You can see the appeal — one tax return, one set of books, multiple properties owned by one LLC, but protected from liability toward one another through the “series” structure.
How Financing Changes When the Property Is Owned by an LLC
Now that we understand the role of an LLC in real estate investment, it might be easy to make the assumption that the investment mortgage loan will be held by the LLC. After all the LLC takes title, owns the operating account, signs the leases … wouldn’t the LLC be the borrower on the mortgage, too?
Actually, it’s not always that simple.
Why Traditional Mortgages Can’t Be Given to LLCs
Many investors choose a conventional mortgage for their rental properties, especially new investors with high-income employment. With strong paystubs, it’s easy to qualify for the lower interest rates, down payments, and origination points available to traditional “qualified mortgages” (QM).
Those investors may be surprised to learn, therefore, that traditional QM mortgage lenders can’t loan to LLCs.
What’s going on? If it’s so common for real estate investors to limit liability and professionalize operations by holding the property in the name of an LLC, why won’t traditional mortgage lenders get with the program?
Traditional mortgage lenders have their hands tied by various Federal laws and governing bodies. For example:
- Traditional mortgages fall under the “Ability-to-Repay” (ATR) framework Dodd-Frank Act. This framework assumes a human borrower and requires verification of personal income and debt. As a business entity, an LLC is not a “person” and has no personal income or debt.
- Traditional loans adhere to guidelines set by agencies like Fannie Mae, Freddie Mac, the VA, FHA, or USDA. These guidelines all stipulate that loans must be made to individual humans, not business entities. To do otherwise would be for the lender to lose the risk-reduction factor of a conforming loan.
- Federal law considers a QM loan a consumer product. Yes, it can be used as a rental, but consumer loans cannot legally be issued to businesses.
Can You Take a Personal Mortgage Loan but Keep LLC Ownership?
Some traditional mortgage lenders will agree to allow the property to be titled in the name of an LLC while the mortgage is in the name of an individual borrower, provided that it is a single-member LLC with that single member as the sole borrower who personally qualifies based on personal income and DTI.
This protects the investor’s liability while satisfying Federal lending requirements. Even business and DSCR loans often require a personal guarantee for the loan, even if the LLC is technically the borrower, so this is functionally little different.
Not all QM lenders will agree to this. If the lender does not, the borrower might try taking title in their name and then transferring the title to the name of the LLC after closing. This resembles a “subject-to” deal and might trigger the “due-on-sale” clause of the mortgage. Many lenders have a reputation of not caring (or never finding out) as long as the mortgage payment arrives on time, but it’s still a risk. If the lender decides to invoke the due-on-sale clause, the lender has the right to call the entire loan due.
LLC Property Financing Differences
If you choose a lender who will issue a loan to an LLC unlike a traditional mortgage lender, here’s what to expect:
- More Documentation. Lenders will require more documentation for LLC loan approval. In particular, they want proof that they’re loaning to a real entity, which means furnishing the LLC founding documents, EIN verification, and possibly a certificate of good standing from the state.
- Different Underwriting Process. Business loans observe different underwriting processes than personal loans — one that focuses on the ability of the LLC to produce enough income to justify the debt. For DSCR loans, this might mean the rent potential of the property. For business working capital loans, this might mean the revenue history of the LLC.
- Personal Guarantees Common. While LLCs protect the owners from personal liability for property operations, lenders rarely agree to liability protection for the repayment of the loan. Lenders to LLCs usually require a personal guarantee from a human borrower, meaning the guarantor is personally responsible for repayment of the loan. The guarantor’s personal assets may be shielded from lawsuits related to the property, but the lender can go after personal assets in the event of default on the loan.
DSCR Loan Under LLC Explained
With a solid understanding of LLC property financing now established, let’s look at one of the most important categories of loan that can easily be acquired by a qualifying borrower in the name of an LLC — the DSCR loan.
What a DSCR Loan Is
A DSCR loan is a kind of mortgage reserved for investment properties. It is not a subprime loan — in fact, it’s considered a kind of “conventional” loan. When people refer to “conventional loans,” they usually mean traditional QM loans. DSCR loans are not QM loans because they do not conform to guidelines set by bodies like Fannie Mae and Freddie Mac. However, they are mature and well-established business lending products.
A DSCR loan is just like a traditional mortgage in many ways — a deed of trust that makes the property collateral for the loan, a promissory note, familiar terms like fixed APRs or ARMs and fully-amortized terms of 15, 30, or 40 years. The interest rates, down payments, and origination points tend to be a little higher, but otherwise the resemblance to the traditional mortgage is striking.
What makes a DSCR loan different is that as a non-QM product, exempt from Dodd-Frank and other Federal laws that govern them. This means the lender is not required to verify the personal income and debt-to-income ratio of the borrower. No pay stubs, no W-2s, no personal tax returns required.
Instead, DSCR loans underwrite based on the income potential of the property. The term “DSCR” alone refers to an income-based metric — the debt service coverage ratio. This is a measurement of the property’s ability to earn enough operating income, minus expenses, to cover the monthly mortgage payment.
What Makes a “DSCR Loan Under LLC” Different
Another consequence of DSCR loans being “non-QM” mortgages is that they are not required by Federal law to be issued to individuals. They can be issued in the name of a limited-liability entity like an LLC — and, in fact, many DSCR lenders prefer it this way.
You can expect all the paperwork requirements of a business loan — submitting the LLC formation paperwork, EIN registration, and possibly a statement of good standing from the Secretary of State’s office. The lender will also need an authorized signer statement from the LLC confirming that the borrower has the right from the LLC to sign loan papers that encumber the LLC with debt.
If you are buying property in a different state than the one where the LLC is registered, you will need to register as a foreign entity with the State Department of the state wherein the property is located.
Most DSCR lenders will also require that the borrower of a DSCR loan under LLC personally guarantee the loan, meaning your liability as an owner is protected from occurrences on the property, but your liability as a borrower extends to personal assets and other LLCs in the event of default.
Like all mortgages, DSCR loans are funded into escrow, from which they go directly to the seller, so you don’t need a business bank account for the lender to wire the proceeds to for acquisition. However, cash-out refinance loans do go directly to the borrower’s bank account, and the DSCR lender will require you to carry cash reserves sufficient to cover several months’ worth of mortgage payments. The name on these bank accounts must match those of the borrower. Therefore, you will need at least one bank account in the name of the business to qualify for a DSCR loan. Expect to submit statements, cancelled checks, and possibly API access to your bank for verification.
Typical DSCR Loan Requirements for LLCs
- Credit Score. The guarantor must still submit to a personal credit check, even if the loan is to be issued to an LLC. Many DSCR lenders have minimum credit score requirements of 660-700, though some DSCR lenders will accept lower scores.
- Down Payment. DSCR loans usually have higher down payment requirements than traditional mortgages, often in the range of 20-25%.
- Reserve Requirements. DSCR lenders require that you have cash reserves in an LLC-owned bank account equal to several months’ worth of PITIA (principal, interest, property taxes, insurance, and association fees). Two months’ worth is common, with some requiring as little as one but others requiring as many as six or more. If you intend to operate the property as an Airbnb or short-term rental, the reserve requirement may be as high as 6-12 months.
- Debt Service Coverage Ratio. DSCR is calculated by dividing the expected NOI (net operating income) by the annual debt service for the loan. This results in a number either greater than 1 (good), or a number less than 1 (not so good). Most DSCR lenders require a DSCR of at least 1, and some require more than 1, especially if the property is to be used as an Airbnb. Lower DSCRs may be considered under special circumstances, often with less favorable terms.
NOI potential may be determined by the appraisal, or by data from aggregators like AirDNA for short-term rentals. Expenses may be pegged to industry benchmarks. If the property has been used as a rental in the past, its trailing 12 months of income statements and existing leases may be used for NOI calculation.
Why DSCR Loans Are the Default Tool for LLC Property Financing
DSCR loans are a mature, established type of mortgage perfect for LLC property financing. Despite their strong resemblance to traditional mortgages, they will gladly fund into an LLC, whereas traditional mortgages are legally prohibited from doing so.
These loans are also a go-to for rental financing because they depend far more on the property’s income potential, with little or no attention paid to the borrower’s pay stubs, W-2s, or personal tax returns.
Additionally, whereas traditional mortgages may stop lending to an individual borrower after that investor has a certain number of mortgages outstanding, DSCR lenders place no limits on the number of DSCR loans they will extend to an individual investor, especially if each loan goes to a different LLC.
Business Credit and Working Capital Loans
DSCR loans aren’t the only types of loans applicable to real estate investors that can be issued to LLCs. Business credit for real estate is widely available for qualified borrowers. It can even be used in conjunction with DSCR loans under LLC, but only under certain circumstances.
What “Business Credit for Real Estate” Actually Means
Business credit refers to a category of loans available to businesses. LLCs are eligible because they are legitimate, registered business entities.
Examples of business credit include:
- Working Capital Loans — term loans or revolving lines of credit, often unsecured, issued to established businesses with a track record of revenue, often at mid-tier to high interest rates, with term loans ranging from 6 months to 10 years.
- Invoice Financing — short-term loans that use outstanding invoices as collateral.
- Merchant Cash Advance — short-term loans that use the company’s merchant account balance as collateral.
- Business Credit Cards — high-interest unsecured revolving credit lines available to businesses, popular because they are relatively easy to get and many come with zero-interest introductory periods.
The reason these loans can be considered “business credit for real estate” is that the proceeds often come with few strings attached. Some lenders, like working capital lenders, require the business to present a business plan or state the intended use of funds, along with evidence of ability to repay. However, once the loan is funded, the borrower can do with the funding as they please.
Examples of real estate uses for these funds include:
- Down payment (with lender-specific restrictions)
- Earnest money deposit (again, with restrictions)
- The entire purchase price (working capital loans can have balances of $500,000 or more, best for short-term initial financing)
- Rehab and renovation costs
- Cash reserves
- Marketing and startup costs
- Furnishing and decoration for Airbnbs and short-term rentals
Why LLCs Use Business Credit Alongside DSCR Loans
DSCR loans are excellent vehicles for LLC property financing, but they have limitations. Consider a new property acquisition. The lender will lend 70-80% of the purchase price, but those funds go straight to escrow, and then directly to the seller. They can’t be used for purposes like renovating the unit or furnishing an Airbnb.
Business credit can be used to fund these expenses. They can even be used as down payment under certain circumstances to create “0% down financing.” The circumstances under which this can be done will be explained below.
Important Distinction: Business Credit vs. Down Payment Funds
Some borrowers view business credit for real estate as “down payment assistance” for investment properties. However, this is inaccurate. While down payment assistance programs exist for aspiring homeowners, no such program exists for real estate investors. Business debt like working capital loans can be used as down payment funds, but restrictions apply (explained below).
How DSCR Lenders View LLC Funds, Business Credit for Real Estate, and Source-of-Funds
We’ve mentioned above that it can be tricky to use business credit for purposes like down payment, earnest money, or reserve requirements. However, it is possible. Munoz Ghezlan Capital has helped numerous investors execute such strategies. To succeed in this strategy, you need to understand how DSCR lenders view business credit for real estate.
How DSCR Lenders Analyze LLC Bank Accounts
Like QM lenders, DSCR lenders will review bank account statements (business bank accounts in this case) to verify down payment, earnest money, and reserve funds, and they do care about the source of those funds. They have more latitude than QM lenders, but they expect transparency, legality, and integrity.
DSCR lenders will usually examine at least one month’s worth of bank statements, often two or more. What they are looking for are large influxes of funds. If they see one, they will ask for an explanation of where the funds came from and possibly perform forensic underwriting to independently verify the source of funds.
In addition to large cash inflows, like all lenders DSCR lenders will consider overdrafts and negative account balance days to be a red flag.
When Business Credit Is Acceptable
Business credit is acceptable as a source of down payment, earnest money, or reserve funding for a DSCR loan under LLC if:
- The DSCR lender agrees to the deal. Not all lenders will agree to the use of business credit for down payment, earnest money deposit, or reserve funds. Munoz Ghezlan Capital keeps track of which ones do.
- The borrower discloses the funds as borrowed. Failure to do so will be treated as a breach of the loan terms and may even constitute mortgage fraud, exposing the borrower to civil or even criminal liability.
- The DSCR calculation still works. Once the borrower discloses the source of funds as borrowed (required by law and the terms of the loan), the lender will factor the extra debt service into the DSCR calculation. The deal must still meet the lender’s DSCR minimums.
When Business Credit Becomes a Red Flag
- Commingling. If business credit is commingled with non-borrowed funds, personal funds, or funds from other businesses leave a bad accounting trail, increasing the risk for everyone.
- The DSCR is on the margin. Business credit often adds significantly to the overall debt service, putting downward pressure on the DSCR. As the DSCR approaches or dips below 1, the lender may begin to see the borrower as at risk of becoming overleveraged.
- Loan-Stacking. Receiving multiple loans over a short period of time may make the lender suspicious of undisclosed loan obligations.
How to Structure LLC Finances to Stay Compliant
- Choose a structure when setting up your LLC. Decide whether all property will be held in the name of one LLC, if the LLC will only hold this property, or if you will use a series LLC if available. Assemble the articles, operating agreement, EIN, certificate of good standing, and authorized signer documentation in one place.
- Get a dedicated LLC bank account as soon as possible. Make sure all rent payments and property expenses run through it to avoid commingling.
- Document all capital contributions. If you make deposits, especially large deposits, into the LLC bank account, keep records and mark it as a member contribution or a loan to the LLC (pick one and stay consistent).
- Use Business Credit for Real Estate Strategically. Consider it for repairs, capital expenditures, reserves, and operating float. If you want to use business credit as down payment, earnest money, or reserves, make sure you choose a DSCR lender who will accept it. Munoz Ghezlan Capital can help you identify such lenders.
- Use the Correct Vesting. Make sure all borrower names, buyer names, and bank account owners match the legal name of the LLC to the letter.
- Don’t Introduce “Mystery Money” Into the Bank Account. Large influxes of unexplained funds can delay underwriting.
Bottom Line
LLCs carry obvious advantages in terms of liability protection, taxes, transferability, and the overall professionalism of your business. The more of your real estate investment, the better. If you were ever told that the financing has to go into your personal name and not into the name of the LLC, don’t listen — that only applies to traditional mortgages.
DSCR loans and business credit can and do loan and fund to LLCs all the time. You can expect to submit more paperwork, face a different underwriting process, and offer a personal guarantee. Extra complications arise when you want to add a working capital loan or other business financing into the mix. But it’s all very doable.
Munoz Ghezlan Capital helps nearly every investor we work with get a DSCR loan under LLC ownership, often with business credit as extra property financing. If you have questions about how it will work for you — or how to get started — schedule a free strategy call with a Munoz Ghezlan expert today. We will help you keep your business financing where it belongs — in the name of the business.
