What is a Non-Recourse Loan?
Self-Directed IRAs and Self-Directed 401k’s are allowed to use leverage (loans) for real estate investments. The loans are called non-recourse. What this means is the lender, either private or commercial cannot ask the owner of the self directed account to personally guarantee the loan. The loan is being made to the self directed account, not the person and the collateral is the real estate itself. Most lenders in the U.S. are merely loan originators and they bundle their loans and sell them on the secondary market. Therefore, most banks will not entertain non recourse loans.
However, there are a few banks who actually lend their own money. This is called portfolio lending. These type of banks will look at the particular investment and decide make the loans or not. Normally, the real estate investment has to make sense, have a positive cash flow and sufficient reserves in case of vacancies. The normal loan to value (LTV) depends upon which state you are investing in but normally runs between 50 to 60%.
The minimum loan amount is generally $50,000. Surprisingly, the banks that understand and underwrite non recourse loans, offer attractive rates and terms. When you think about it, if they are only loaning 50 to 60%, it is a pretty safe loan for them.
A private non-recourse loan can have any LTV – it would be a negotiated loan.
What are The Upsides of Non Recources Loans for Self-Directed Accounts
Leveraging the self directed funds through such non recourse loans enables borrowers to make more investments in real estate (for example) than they could otherwise make. If the borrowers are smart investors making quality investments, leveraging their funds through non-recourse loans can definitely multiply the returns in their retirement account.
Another benefit of leveraging is the ability to enjoy better diversification. Instead of investing in a single property by using the entire savings, borrowers can invest in multiple properties at the same time and with the same amount of money.
Another important but indirect benefit is, the chances of ending up on the losing side are limited to the amount invested in the new property. Since the collateral clause is only limited to the property, if the borrower decides to walk away and stop repaying the loan, the lender can only repossess the property, without asking for reimbursing the additional damage costs, hurting the borrower’s credit, or taking any other probable action against the investor.
What are The Downsides of Non-recource loans for Self-Directed Accounts
There is a tax called UBIT (Unrelated Business Income Tax). It applies to profits made within self directed accounts. It can apply if a self directed account runs a business inside the account. Operating a business is allowed, but to keep the playing field fair, the self directed account will have to pay income taxes on the net profit
UBIT can also apply to profits made using leverage in real estate investments. UBIT treats self directed IRA’s differently than Self Directed 401 k’s. In the case of a self directed IRA, the portion of the net rents or net profits that resulted from a non recourse loan will be taxed at corporate tax rate – even if using a self directed Roth IRA. However, this tax does not apply using leverage inside a self directed 401k. This can make a huge difference in the growth of your retirement account.
At Self Directed Retirement Plans LLC, a lot of our first time incoming calls or emails are looking for information about using a Self Directed IRA to invest in real estate. When we dig down a little, we find a lot of these clients can qualify for a self directed 401 k instead of the vanilla self directed IRA. When we explain UBIT, they are very happy to graduate to a self directed 401 k.
Non-recourse loans provide an incredible opportunity for the self-directed account holders to leverage their retirement funds, make additional investments, and increase their returns at a relatively lower risk. They are not difficult to obtain if you work with a bank that understands them. Through the years we have helped many clients obtain non recourse loans and most are pleasantly surprised at the rate and terms.
List of Non-Recourse Lenders List
Please call or email us at Self Directed Retirement Plans LLC and we will be happy to answer your questions.
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He brings over 30 years of diverse experience as a financial advisor. Rick takes great pride in giving honest and very experienced advice. Rick can readily converse with business owners and people looking to take control of their retirement accounts.