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Landing loans for rental properties
Dear Small Biz
Adviser:
I own five residential properties. One is my primary home, and the
other four are being rented. I need to make some repairs and improvements
to the rental properties and need a loan to do so. I am looking
at home equity loans. However, the banks only consider one's primary
residence for home equity loans. I have a lot of equity on the four
rented properties and not much on my primary residence. Is there
a bank that would give me a home equity loan on one of the rented
properties so that I can finance the repairs and maintenance? Is
my situation considered a small business where I can benefit from
the Small Business Administration benefits if there are any?
Thanks,
Emmanuel
Dear Emmanuel:
It appears you have purchased these rental properties in your name,
as personal investments. It appears you have a proprietorship owning,
renting and operating the properties.
It is very likely you have been filing a Schedule
C, Schedule
E and Form
4562 with your individual income tax Form
1040 filings every year. These are standard forms, respectively,
for supplemental income, income or loss from rental properties and
depreciation and amortization of real property.
Since you failed to inform me regarding the status
of any liens that may exist and the details on the equity built
up in those properties, I am not able to give you a comprehensive
response. However, let me offer some general approaches to leveraging
the value of the rental properties.
Laying loan groundwork
Begin by securing an appraisal of all the properties, your main
residence included. This would be mandatory when applying for any
form of funding associated with lines of credit, first and second
mortgages on residential and rental properties.
Next, speak directly with the holder of your residential
mortgage. Bring all the property appraisals and a summary of all
outstanding balances of notes or liens. You will also want to provide
a list of all sources of income for you and your spouse, if married.
It would be most preferable to bring in your income tax returns
for the last three years, as this tax information is a standard
request before any loan is processed.
Finally, bring in a line-item income and cash flow
statement from the rental properties for the last 12 months. The
lender wants assurance these are profitable concerns.
When discussing loan alternatives, you may want to
consider:
- An equity line of credit that incorporates all
or part of the rental properties: The attractiveness of this
form of loan is that interest rates on this instrument are lower
than for first and second mortgages at this time. Granted, they
are typically adjusted every 12 months, but you start with a lower
rate than a second mortgage on the home. Likewise, there is no
prepayment penalty, allowing you to substantially reduce outstanding
principal at an accelerated pace, positive cash flow allowing.
- A second mortgage against the home: This
would be the course to take if that property is the most lucrative.
I am assuming the appraised value on your home would be higher
than any single rental property.
- A home equity line of credit against your home:
This would carry the same pros and cons outlined above.
- A refinancing of your residential mortgage:
Whether this would be an attractive alternative depends on your
financing history on the home.
- A combination of loan instruments: You may
be better served by incorporating all of the four options listed
above.
In short, you have a wide menu from which to work
out a financing deal. Don't be content with the feedback from only
one lender. Even if you bank at ABC Savings, another bank or savings
institution may be more willing to work with you.
Also, don't overlook the importance of your credit
rating. That score will play the biggest role with any lender deciding
whether to work with you on this matter. The recession has
resulted in lenders tightening their demands on loan applications.
Bad or average credit will not endear you well to the lender. You
need good or excellent credit to be considered by reputable, long-standing
banks and savings banks.
Finally, you may want to consider an alternative form
of legal business structure. Apart from proprietorship, you can
consider the S or C corporation, limited liability company, and
a combination of one of those forms in a partnership, if someone
else owns these properties with you.
The Internal
Revenue Service Legal Business Structure Comparison Chart and
the FAQ
page at Corporate Creations provide a good starting point from
which to consider alternatives to proprietorship.
I wish you well.
-- Posted: June 6, 2002
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