How to Invest in Real Estate using a Non-Recourse Loan
If you don’t have the funds in your IRA to make a real estate investment, one available option is a non-recourse loan. With this process, the borrower is the IRA itself, not the IRA owner. Non-recourse loans are not offered by most banks— though there are some banks and private lenders willing to grant this type of loan. Due to the uncommon nature of this funding, not every IRA provider, lender, or real estate professional may be familiar with the process.
A non-recourse loan is a loan where the IRA account holder is not personally liable for repayment of the loan. The loan is in the name of the IRA, not the individual IRA owner. In the event of default or foreclosure, the lender can look only to the property as the source of repayment— the IRA owner’s other assets are excluded. The non-recourse lender cannot legally pursue personal assets owned by the account holder or the IRA. You can see why this would be an attractive option for Real Estate IRA Investors.
With over 6 years of experience working with IRA investors and non-recourse lenders, I have seen it all. Here are a few things I recommend you keep in mind.
Getting a Non-Recourse Loan for your IRA
To get a non-recourse loan, you must first have an established self-directed IRA. If you don’t have a self-directed IRA, an IRA Resources representative can help you establish an account. To begin the loan process, research all lenders before you apply for the loan. Most banks do not offer these types of loans, and large national banks will not even allow a real estate IRA transaction. IRA Resources has a list of non-recourse lenders we have worked with in the past, which you can find on the non-recourse lenders page.
When you apply for the loan, you will need to provide statements for your IRA. The lender will use these statements to verify the IRA has the funds available for purchase, closing costs, and reserves. The IRA reserve requirements will vary from lender to lender, but may be up to 20% of loan amount. You are required to have these reserves in the event of insufficient cash flow to pay operating expenses and mortgage payments.
Loan terms can vary from a 3-, 5-, or 10-Year ARM, to a 10-, 15-, 20-, or 30-Year Fixed, or even a 25-year, fully amortizing loan with no prepayment penalty. The loan terms will vary from lender to lender, depending on the individual situation and investment.
Requirements and Restrictions
Though every lender has different requirements, some requirements are similar. Here are some things to keep in mind no matter what lender you end up choosing:
- Depending on the lender, some properties may not be eligible for a non-recourse loan. This varies between lenders, so clarify with the individual loan provider when applying.
- Not all lenders offer nationwide loans— make sure your lender meets your individual needs before proceeding.
- Your IRA will need to have enough funds available for closing costs and reserves, beyond the property price. How much you need to keep on hand varies depending on the individual lender.
- The property must be held in the name of the IRA and not the IRA owner.
- Although your personal credit does not come into play with a non-recourse loan, you may be asked to provide personal information for you and your spouse.
- The property must be an income producing investment. Properties must meet the debt service coverage ratio – net operating income/annual debt service. This means that the property must have a positive cash flow, after the rent is “discounted” for vacancies, utilities, etc.
- The lender will ask for an appraisal. The appraisal needs to be paid from the IRA funds, not personal funds. The IRA is responsible for all income and expenses (including inspections) during the purchase process and beyond.
- With hazard insurance, you will need to provide contact information for an insurance agent for the proposed property, and the insurance must be titled in the name of the IRA. Insurance in your name personally will not be accepted by lenders.
- The lender may require that the “loss payee” clause of hazard insurance be in the lenders name.
Typical Fees at Closing
As with any other real estate purchase, there are closing costs. These costs must come from the IRA and not your personal funds, so make sure to have enough cash available within the IRA. You can request an estimate of potential costs from your lender in advance. If you do not have enough funds in your IRA, you can make a contribution (if you haven’t maxed out your contributions for the year) or transfer from another IRA if available.
Example of fees you may encounter during this process:
Time Frame for a Non-Recourse Loan
Typically, IRA Resources, Inc. clients have seen their non-recourse transactions process somewhere between 30-45 days’ time, from the date the lender receives your loan application. This process and timing is not the same for all IRA providers. Experience is a key factor in getting your transaction completed timely.
Other factors that come in to play is how your deal is structured, the negotiating time, and the experience of the IRA provider’s staff, any of which can significantly speed or slow the transaction— an error during this process can significantly delay the purchase process.
Taxes Associated with Non-Recourse Loans
You may be subject to Unrelated Debt-Financed Income (UDFI) when using a non-recourse loan to fund your transaction. Unrelated Debt-Financed Income (UDFI) is a tax on any income that derives from the use of “acquisition indebtedness” in self-directed IRA investments. “Acquisition Indebtedness” in this situation would refer to income from a property where debt is incurred during the acquisition of the property.
For example, say your IRA Resources account uses $100,000 in existing funds, combined with a non-recourse loan in the amount of $100,000, to buy a $200,000 investment property that generates $10,000 annual gross income. UDFI would apply to $5,000 of the profit (50% of the income), as 50% of the investment was debt financed by the loan. Having UDFI also may require filing a Form 990-T with the IRS. Consult with a tax advisor before engaging in a transaction that may result in UDFI to clarify your expenses and obligations.
IRAR has been helping clients purchase real estate with their IRA for over 21 years. For more information on non-recourse loans or to get a list of lenders, please contact us at 888-322-6534. We’d be happy to help!