One common way real estate owners, especially those with rentals or other kinds of investment properties, hold title to property is in the name of a limited liability company (LLC). The primary reason small business owners choose to form an LLC is to avoid being held personally liable for debts should the business become unable to pay its creditors. Put another way, only an LLC member's investment in the LLC is usually at risk, not their personal assets.
But even if you take out a mortgage in the name of the LLC, you could be liable for a deficiency judgment following a foreclosure. Whether you'll face a deficiency judgment depends on the circumstances, like if you gave a personal guarantee for the loan.
Individuals who create an LLC generally do it to shield themselves from personal liability. By forming an LLC, you and your business will be considered separate legal entities. Creditors then can't go after your personal assets to pay business debts—even if the business can't pay them.
So, forming an LLC for your rental property business or even for each rental property you own is probably a good idea. Having an LLC provides extra legal protection between your personal and business assets and helps protect you from personal liability. (You should also be sure to have adequate insurance in place and consider also getting an umbrella policy.)
To get a mortgage loan under an LLC's name, like for a rental property, you must prove to the lender that you have a legitimate business. So, you'll most likely need to provide:
Still, lenders sometimes won't make LLC loans. And if you deed your property to the LLC after getting a mortgage in your name, you might have to guarantee the mortgage personally.
Or if you deed your property to the LLC after getting a mortgage in your name, depending on the loan terms, the lender might accelerate the loan (demand you pay the entire balance immediately). If your mortgage has a due-on-sale clause and finds out you transferred the property's ownership to an LLC, they might call the loan due because you violated this clause.
Even if a lender will put the mortgage in the LLC's name, you might have to guarantee the loan. In fact, unless you're an experienced landlord with a record of profitable rentals, the lender will likely ask you to guarantee the mortgage personally.
Signing a personal guarantee for an LLC mortgage is the same as co-signing the loan. So, in addition to reviewing the items above, the lender will review your personal credit history and assets. And if you personally guarantee the mortgage loan, you're equally liable to repay the debt if the LLC defaults on it.
After you personally guarantee an LLC's mortgage obligation (and default on the loan), the creditor can foreclose. It can also come after your personal assets if the foreclosure sale price isn't enough to repay the debt.
Again, lenders usually won't finance an LLC mortgage loan based only on business credit unless that business has an excellent and long-established credit history. Banks know that LLC members and shareholders can't be held personally liable for the LLC's debts. So, many lenders will only extend a mortgage loan to a small LLC if the business owner gives a personal guarantee.
By signing a personal guarantee, you're volunteering your personal assets as security for the debt if the business can't repay the loan. Suppose the lender forecloses on a rental property. In that case, you can be held personally liable for any remaining debt if the foreclosure sale doesn't bring in enough to pay off the loan. The lender can sue you for a deficiency judgment if the LLC's assets don't cover the debt and so long as state law doesn't prohibit it. Certain states prohibit deficiency judgments under particular circumstances.
Generally, once the lender gets a deficiency judgment, it may collect the deficiency from you using collection methods such as garnishing wages or levying a bank account. Whether your lender can go to court and get a judgment against you for the deficiency and then collect it, again, depends on state law.
Another way you might potentially open yourself up to personal liability is by signing the mortgage documents, such as the promissory note, in your own name instead of the name of the LLC. By signing your name rather than on behalf of the LLC in your capacity as a member, you could be held personally liable for the debt.
If a court decides you've "pierced the corporate veil," you can be held personally liable for an LLC's debts and obligations. Piercing the veil happens when no real separation exists between the LLC and its members, such as when the LLC fails to keep the finances of the members and the LLC separate.
Here are a few ways to minimize your risk and limit your personal liability for an LLC mortgage.
If you own rental property, it's generally a good idea to hold the property's title and any mortgage on the property in the name of an LLC. This step helps limit your liability and also builds a credit history for your rental business.
On the downside, getting a lender to provide an LLC mortgage might be challenging, particularly if you don't provide a personal guarantee.
As discussed in this article, the main benefit of financing a property under an LLC instead of in your own name is protecting your personal assets from lawsuits, business loans, and other LLC debts. If you're sued, the other party can attempt to hold only your company liable, rather than you personally. So, your personal belongings, such as a home, vehicle, or other assets aren't put at risk.
Suppose you own a rental property and have it mortgaged and titled in your own name. In that case, you're subject to personal liability for any debts or obligations that arise from owning the property. But if you put the property's title and mortgage in the name of an LLC, you can protect yourself from being personally liable for debts and obligations associated with the property. While the LLC's assets are subject to creditors' claims, the creditor can't go after your personal assets if the LLC's assets won't satisfy the claim.
Again, you'll have to be careful not to pierce the veil, you must adequately fund the LLC for its operations, and you should be sure to keep your personal and LLC assets separate. And to be safe, get sufficient liability insurance and perhaps also an umbrella policy.
Another benefit to getting an LLC mortgage is that this step establishes a business payment and credit history for your LLC. So, in the future, you might be able to get another LLC mortgage more easily.
On the downside, getting an LLC mortgage is usually difficult, especially for the first time. Lenders don't like to lend to LLCs because of the limited liability it offers. So, your lender might require a personal guarantee. Many lenders will give mortgage loans to an LLC if the business owner agrees to put up their own personal assets to guarantee the loan.
And some lenders don't offer LLC mortgages at all.
The best advice about what to do when you're personally liable for an LLC mortgage is to avoid defaulting.
If you're having trouble making the mortgage payments on an investment property, like a single-family home you rent to tenants, you might be able to work out a way to avoid a foreclosure.
Don't overlook your personal liability risks when signing any mortgage loan documents. Be sure to carefully read the contract to determine if it obligates you personally in addition to the LLC.
If you have any questions about personal liability regarding a mortgage transaction or if you are facing foreclosure of an LLC mortgage on an investment property, consider talking to a qualified attorney who can advise you about what to do in your particular situation.