This is truly a pet peeve for us at Lawgavulon. Almost every other week Rolandovich gets a call which invariable has the following tale: "Hi, I'm a small investor in real estate. I want to shield my personal assets from liability and therefor transfer my home/duplex/tri-plex into an LLC. My real estate agent said it really wasn't a big deal, can you quitclaim my home/duplex/tri-plex to my LLC? What, ohh, you want to know whether my loan is in the name of the LLC. Well actually it's not. You see my real estate agent told me that it would be cheaper to obtain an owner-occupied FNMA loan. As a result we couldn't close in the name of the LLC, but I saved a lot of money. My loan officer even helped me set up the LLC and said I should quitclaim the property after closing. Why, is there a problem?"
Here are the problems:
(1) DUE ON SALE CLAUSE. Practically every single loan has a "due-on sale" clause in it. These clauses state that if the current property owner sells the property without seeking lender approval, then the lender may call the loan due. Thus, a transfer of your home/duplex/tri-plex into an LLC will violate the due-on sale clause and the lender could foreclose on you on any time.
"But Rolandovich, it's not illegal to transfer my home without lender approval."
Yes, that's true. It's not illegal. You are merely breaching your contract that you have with your lender. So feel safe, you won't go to jail, you might just lose your investment property.
"But Rolandovich, everyone tells me that banks have no way of knowing that I've transferred the investment property."
Yes and No. It's true Lenders generally have no knowledge of what is recorded subsequent to their loan. They generally do not check the recorder's office after the loan is collateralized and the lender has earned their points. But one should be careful. Back in the last 1970's when interest rates were rising and lenders had nothing to do they decided to "audit" their loan files. Invariably they found many properties that had been transferred without their approval. This allowed the loan officers to "call due" the loan and force the borrower into a much higher interest rate loan. (i.e. you are in default. So we will foreclose and you the investor will have to refinance). During the late 1970's interest rates had shot up to 15-18%. Thus the incentive was high for lenders to get people out of those loans that didn't earn much money for them.
Lenders receive a copy of your homeowner's insurance policy. If you want to keep any kind of insurance on the property then the "named insured" would have to be changed to the LLC and as such the lender will find out that the property was transferred when they receive their certificate of insurance coverage. This could be the trigger forcing the investor to refinance. Or I suppose we can all hope that lenders receive so much paperwork that they just won't read or review the insurance certificates sent to them.
"But Rolandovich, I was told that the Gairn-St. Germain Act allows me to transfer my property into an LLC without lender approval."
No. That is false. The Gairn-St. Germain act is a federal law that allows borrowers to transfer their homes into a Revocable Living Trust of which they are the trustee without the loan being called due. This federal law does not apply to LLCs or other corporate forms and a living trust is an estate planning tool, it doesn't actually protect any of your assets from creditors.
(2) HOMEOWNERS INSURANCE. As briefly mentioned above, your homeowners insurance will have a "named insured" and that will be the property owner. Once you transfer your property into an LLC, you need to either change the insurance policy to cover the LLC or you will be paying insurance that does not actually cover you. For example, if you transferred your investment property into an LLC and did not change the "named insured" and then the property burned down - well I can almost guarantee you that the insurance company will not pay that claim as they never insured your LLC - only you and you no longer own the property.
So as an alternative you can transfer the investment property into an LLC and change your homeowner's insurance - but then you run into potential problems with your lender, as explained above.
As a result some people transfer their properties into an LLC without lender approval and continue paying homeowner's insurance which won't actually cover them if a claim is filed. I'm sorry, but isn't that just ludicrous?
(3) TITLE INSURANCE. At closing you will have received Title Insurance insuring you against loss from title defects. That insurance will also be issued in your personal name. If you transfer the property into an LLC without obtaining a "rider" on your Title Insurance policy to insure the LLC, then once again you will be without insurance if there is a title claim.
This problem can be remedied relatively easily. A Title Insurance rider to cover your LLC should only cost $75.00 or so and the good news is that such a rider is not sent to your lender and so you won't inform your lender of what you have done by this move.
(4) DO YOU REALLY HAVE LIABILITY PROTECTION? The whole purpose of transferring the investment property into an LLC was to create a liability shield. However, if you transfer property into an LLC but the loan on the property is in your personal name, are your personal assets actually protected? In most states a plaintiff who sues you will check to make sure that you have met all corporate formalities. The easiest way to "pierce the corporate veil" is to show that someone has not kept their personal finances separate from their business finances. If your loan is still in your personal name but the LLC own the property, I posit that your liability protection is more illusionary than anything. It's a corporate veil waiting to be pierced.
So the lesson is to either (1) Form an LLC prior to closing on an investment property + get the lender on board with the concept. Do not obtain an owner occupied FNMA loan, but rather an investment grade loan that will close in the name of the LLC. You will be above board. There will be liability protection and far less risk; (2) Don't close in the name of an LLC. Just buy the property in your own name and carry a good insurance policy. Don't bother transferring into an LLC. It's just not worth it.
The above is not to be construed as legal advice. Do no rely on it. Seek the advice of an attorney before closing a real estate transaction. Relying on the advice of your attorney will keep you out of hot water much better than relying on the advice of your real estate agent or loan officer whose only true goal is to close the deal and thereby earn a commission. The attorney, who is generally paid by the hour, will only have your best interests in mind.
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1 comment:
Joe - and I responded on the bubble blog (under Thursday). Again, I would love to know who your attorney is. Perhaps I'll fire my attorney if your guy is right ;-)
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