How to Harness the Power of IRA Non-Recourse Loans for Real Estate Investing
Investors have always known the power of real estate to enhance their retirement portfolios, but few realize they have the option to leverage self-directed retirement accounts to purchase investment property.
Since the creation of the IRA in 1974, individuals have had the option to purchase investment real estate within their self-directed retirement accounts such as an IRA, IRA/LLC or self-directed 401(k) plan. The drawback was that the property had to be purchased outright with retirement funds.
Today, however, there are more options. And while property may still be purchased outright with funds from self-directed retirement accounts, investors may also partner with another investor or entity (divide ownership on title) or make use of a non-recourse loan to help facilitate the real estate purchase with the assets in these retirement accounts.
An investor can use his self-directed retirement funds for the down payment while financing the remaining amount with a non-recourse loan. A non-recourse loan is secured by the collateral (real estate) and allows no recourse against the individual account holders or the balances of their retirement accounts.
Debt financing is a concept real estate investors have used for decades, and the fact that they can now leverage their retirement assets gives them more opportunity for diversification without tying up all of the account holder’s funds in a limited number of assets.
HOW DOES IT WORK?
Anyone who normally has a minimum 30 percent to 40 percent of the purchase price vested in a self-directed IRA or similar retirement plan has the opportunity to purchase rental property using a non-recourse loan. The property can’t be owner-occupied or used for personal or business-related activities by the self-directed account holder. Also, the financed property typically must generate sufficient net operating income (rental income minus operating expenses) to exceed the debt payments by 25 percent. The self-directed assets must be managed by a custodian or administrator to meet the requirements of the IRS.
The lender will confirm that enough funds exist for the down payment plus liquid reserves to handle any deficiencies or unknown expenses, which will vary depending on the property. The IRS requires that all expenses be paid by the self-directed account on the title.
WHAT ARE THE BENEFITS?
One of the largest benefits is that there is no income, employment verification or minimum credit score required for a loan approval. Because the account holder isn’t personally guaranteeing the loan, the decision isn’t based on credit nor does it affect any other personal loans in the account holder’s name. The non-recourse loan isn’t reported to the credit bureaus since it’s recorded under the Tax ID number of the entity on title and not the account holder’s personal Social Security number. Should the investment property ever be foreclosed on, it doesn’t reflect on the individual’s credit report.
HOW DO I GET STARTED?
Because there is no employment or income verification, the documentation process required to attain a non-recourse loan is very straightforward. It requires:
LOAN APPLICATION
• Full appraisal with rent comparables (ordered by the lender).
• Current signed leases (if applicable).
• Most recent asset statement verifying self-directed assets for the down payment and reserves.
• Purchase contract, signed by the custodian or administrator of the account. The buyer on the real estate contract must be the name of the self-directed account. (Example: ABC IRA, Custodian FBO John Smith IRA)
The idea of the non-recourse loan is new to many people, but the concept of leveraging money to invest in real estate is not. Non-recourse loans allow investors to take advantage of the powerful returns available in real estate using money they can now leverage for maximum gain.
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