Self-directed IRAs are becoming more popular as investors look for ways to take more control over their retirement investments, and one of biggest selling points for self-directed IRAs is the ability to leverage IRA funds through loans. Not just any loan will work, though. According to the IRS, an individual cannot personally guarantee loans on behalf of their IRA. So in order to obtain a loan for one’s IRA, the loan must be of the “non-recourse” variety. A non-recourse loan is simply a loan that does not require a personal guaranty from the borrower. It does not mean that there is no collateral for the loan, however. In a normal real estate loan scenario, if the borrower defaults the lender can repossess the property in addition to seeking damages from the borrower through collection efforts. In the case of a non-recourse loan the lender is only able to repossess the property – that’s it. While this probably sounds great to most investors, there are some downsides to non-recourse loans which we will discuss shortly.
The Benefits Of Non-Recourse Loans
The benefits of non-recourse loans are fairly self evident. Leveraging your IRA funds allows you to purchase more property than you otherwise could have. Assuming you are a smart investor, and are purchasing quality investments, the ability to leverage your funds means a dramatic increase in the potential rate of return you can earn inside your retirement account.
Another benefit to leveraging your IRA is the ability to achieve greater diversification. Instead of buying one property entirely with cash, you can purchase multiple properties with the same amount of cash using leverage.
In addition, with a non-recourse loan the downside risk is limited to the amount of money you have invested. Remember, if the borrower decides to stop paying the loan and walk away, the only recourse the lender has is to repossess the property. The lender cannot seek additional damages, hurt the investor’s credit, or take any other action against the borrower. If you put $20,000 down on a property, and get a non-recourse loan for the balance, the most money you can lose in the deal (assuming you didn’t invest any additional money in the property after purchase) is $20,000.
The Drawbacks To Non-Recourse Loans
The main drawback to non-recourse loans is that they are incredibly hard to get. There are really only two banks actively offering non-recourse loans on a national basis. Want to know how many loans the largest one closed over the past five years? 1,000 – or roughly four loans a week. For the largest lender, and one who lends in all 50 states, that number is incredibly low. Having worked with countless investors who tried to get loans with these institutions, I can say that they are incredibly picky. They will only consider loans on certain types of property, with certain returns in certain locations. If the investment property doesn’t fit into their tiny little box – forget about it. If you are able to find a property that fits their loan profile (congratulations by the way), you are rewarded with interest rates much higher than traditional mortgage rates, and an incredibly high down payment requirement.
Another thing to consider when looking at non-recourse loans, is that if you take out a loan on behalf of your IRA you will be subjected to a tax called UBIT (Unrelated Business Income Tax) on the financed portion. Before you immediately rule out non-recourse loans because of UBIT, though, let me explain something important about UBIT. Just like with your normal tax returns, when calculating UBIT tax you are able to write off an incredible amount of deductions. Mortgage interest, real estate taxes, maintenance, management fees, and so on are all deductable. In my experience, the actual UBIT amount that most investors end up owing at the end of the day is fairly minimal. Now for full disclosure, I’m not a CPA, attorney or tax advisor. Before proceeding with a non-recourse loan, it is advisable to contact your advisor and discuss the impact of UBIT in your specific situation. If you’re advisor is unaware of what UBIT is (this is very common by the way), I would be happy to refer you to a professional that is well versed in UBIT.
Where Else Can I Get A Non-Recourse Loan?
As I stated earlier, your chances of getting approved for a non-recourse loan through one of these banks is very small – that is just the way it is. I’m not saying don’t give it a try, but if you truly want to leverage your IRA account it is probably a good idea to look at some alternative solutions as well. The good news is that there are a growing number of them.
Do you have friends with a sizeable amount of cash sitting around? If so, maybe you can convince them to lend it to you in the form of a non-recourse loan. Again, you can negotiate the terms however you’d like in this scenario – so the potential is only limited by your contacts and negotiation skills.
Some hard money lenders are beginning to offer non-recourse loans, however, there are some things to keep in mind regarding hard money lenders. Number one is that they are expensive. Hard money lenders are going to charge you a considerable amount of points upfront for the loan, and then you can also expect an interest rate at least double what a typical mortgage might be. In addition it is very rare to find a hard money loan with a term of 15 or 30 years. Typically hard money lenders want in and out of their loans fairly quickly. If your investment timeframe is more than 3-5 years, hard money lenders are probably out of the question.
Before I leave the alternative loan sources topic, I want to explain something my company Hanover is doing that is setting us apart in the industry. For over 43 years we have been partnering with real estate investors by providing them with turn-key investment properties. When self-directed IRAs starting becoming popular a few years back we saw the potential that leveraging IRAs offered, and we wanted to help our investors take advantage of this potential. Unfortunately working with non-recourse banks proved to be most difficult, and our investors soon became soured on the idea. So we decided to do something that no one else was – we went out and got our properties pre-approved for non-recourse financing. The kicker is we got them pre-approved with terms much better than what investors would be able to get from any of the non-recourse lenders.
For example, we currently have a development down in Fort Myers, FL which we bought as a repo from a small local bank. The developer of this golf course community ran into trouble when the real estate market collapsed, and ended up losing the property. As part of the deal we had the bank agree to offer our investors – who we intended to resell the finished units to – special non-recourse financing at 4.75% with 30 year amortization (unheard of for non-recourse loans). They agreed to the arrangement, and so we proceeded with the deal. This went so well for us, that we intend to do the same thing with future properties, and I assume others in the industry will soon begin to follow our lead in this.
Non-recourse loans can be an incredible way for self-directed IRA investors to leverage their IRA funds – providing investors with increased returns, diversification and lower risk. However, obtaining a non-recourse loan is easier said than done. Are more banks going to start offering non-recourse loans? I don’t see it happening anytime soon. The best opportunity for self-directed IRA investors to find a non-recourse loan is in the growing non-traditional loan space, like the special non-recourse loan arrangement my company is offering to self-directed IRA investors, that is where I see the potential.