Do You Have an LLC? You Might Not Want to After Reading This
Rules to refinance properties have just been changed and that means that hundreds of thousands of real estate investments are now in the wrong business structure. Freddie Mac, one of the two largest underwriters of conforming loans on the secondary market, has just changed their internal rules to state that they will no longer refinance a property that has been inside of a Limited Liability Company (LLC) for any time within the past 6 months.
Fannie Mae, the other big underwriter, is expected to follow suit with a similar change.
Conforming loans are typically used for single family homes and four unit properties (also known as four-plexes or four family homes) that fall within certain loan limitations. It’s the backing of Freddie and Fannie that keep the loan rates for these type of loans so much lower than the rates for stated income, jumbo loans and any other loan that doesn’t fit within their criteria. In other words, if you’ve got a great deal on your loan, chances are it was underwritten by Freddie or Fannie.
With this change (and proposed change in the case of Fannie), that means if you have a conforming loan, you have 3 choices:
(1) Never refinance. This is not my favorite strategy because you end up losing the velocity of your money.
(2) Go bare. Don’t put it in a business structure to protect the asset. This is definitely NOT recommended. You put all of your personal assets at risk with this plan.
(3) Use a Trust Sandwich™. The Trust Sandwich puts a Living Trust in place to hold the asset, the LLC owns the beneficial interest and there is then a second Living Trust to provide estate planning as well. It’s the best of all worlds.
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Diane, As usual, you are on top of the market here and giving this community some great ‘heads-up’ advice.
The question that comes to mind immediately relates to current LLCs and properties owned in those LLCs. For those, is there a reaonsable path to get a Living Trust to hold those assets, or do you see this strategy working more for new investments?
Thanks, Pittsburgh Mike
Hi Mike
This strategy is ESPECIALLY for existing LLCs. Otherwise, you’re going to get stuck never being able to refinance.
Would this apply to properties merely titled in an LLC, but the mortgage to be refinanced is solely taken out by an individual, with no reference made to the LLC?
If so, what is Freddie Mac’s rationale for making this change?
-Neal
This is true for properties titled in an LLC.
Why? Who knows. My best guess is that they are trying to say investors were really speculators and they’re throwing them under the bus.
But I don’t really know.
Diane:
If the property is titled in an LLC, and you get a commerical loan, I assume you will be ok since these will not be under the Fannie and Freddie guidlines correct?
Thanks.
Jim
Jim - Yes, you’re right. Freddie and Fannie handle conforming loans which are single family homes and houses that are four family (four-plex) and under.
This does not apply to commercial loans.
Diane, I have quite a few real estate investor clients who need to know about this. I can’t find this on the Freddie Mac site. Would you tell me where I can find this information so I can properly share it with my clients? Thanks.
I think I now understand the basics of the Trust Sandwich, but this has brought to light a follow-up question – are there different state laws for Living Trusts related to LLCs? For example, I have an LLC in Pennsylvania and I am pretty sure that a Pennsylvania Living Trust CANNOT be owned by an LLC by law, so I’m not sure if this strategy works for Pennsylvania? It could be that I am misunderstanding some of the mechanics of this, though?
Also, do you have any info that cites this change from Freddie Mac? I can’t seem to locate it on their website and I’d like to read the specifics to see if there is anything specific to the Pennsylvania laws.
Thanks!
Pittsburgh Mike
Hi Mike,
According to the Uniform Trust Code that was adopted in PA in 2006, a beneficiary must be a person.
However, if you read the definition of “person,” you get: “an individual, corporation, business trust, estate, trust, partnership, limited liability company, association, joint venture, government; governmental subdivision, agency, or instrumentality; public corporation, or any other legal or commercial entity.”
The Uniform Trust Code has been adopted in the following states so far: Alabama, Arkansas, District of Columbia, Florida, Kansas, Maine, Missouri, Nebraska, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Utah, Virginia and Wyoming. It’s been introduced and is up for approval in Arizona, Connecticut, Massachusetts and Oklahoma so far in 2008.
So, I think you’re okay, but you’re absolutely right though - it’s always worth looking at the law before jumping into anything!
Just a little bit on the principals of a trust:
trustor/grantor - puts the trust property into the trust
trustee - makes the management decisions
beneficiary - receives the benefit
No one really owns a trust, per se.