If you want to invest in assets with your self-directed Individual Retirement Account (IRA), you may have encountered the term non-recourse loan. While beneficial, this lending arrangement confuses many people. Thus, we have prepared this blog post explaining non-recourse loans and how they differ from recourse loans. You will also learn the eligibility requirements, the process for getting a recourse loan, the benefits, the downsides and tax implications. Read on to learn more, or contact Accuplan Benefits Services to get started.
What Is a Non-Recourse Loan?
A non-recourse loan is secured by collateral. If you default on the loan, the lender can seize the collateral but cannot go after your other assets. Most investors use this arrangement when buying real estate properties with their self-directed IRA, giving them greater control and flexibility to grow their investments.
In contrast, with recourse loans, the lender can pursue your other properties to recoup their losses if you default. For this reason, most lenders prefer to offer recourse loans, but the option is not available in self-directed IRAs. Non-recourse loans typically have higher interest rates and strict requirements due to the risks they pose to lenders. However, the arrangement is beneficial to borrowers as it limits their liability.
How Does a Non-Recourse Loan Work in an IRA?
The Internal Revenue Code (IRC) prohibits an IRA account holder from personally guaranteeing a retirement accounting loan. In other words, if you have an IRA, whether self-directed or not, you cannot use a standard loan, like a mortgage, as part of an IRA transaction. To navigate this restriction, self-directed IRA account holders turn to non-recourse loans as a financing option.
Non-recourse loans do not require the borrower to guarantee the loan. Instead, the lender secures the loan with the underlying asset for which the loan is secured. If the borrower cannot repay the loan, the lender’s remedy is only against that underlying asset, shielding the others.
Eligibility Requirement for Getting a Non-Recourse Loan Through an IRA
You must meet certain conditions to obtain a non-recourse loan in your IRA. These include:
- Self-directed account: You must have a self-directed IRA, which allows you to invest in real estate or other assets unavailable in traditional IRAs.
- Creditworthiness: Non-recourse loans have strict requirements since the lender’s risk is high. Generally, you need a good credit score and a stable income source.
- Non-prohibited transaction: The investment must not be a prohibited transaction as defined by the IRS code. For example, the transaction must not involve a disqualified person, such as a relative or person with whom you have a business connection.
How to Get a Non-Recourse Loan in an IRA
Follow the steps below to get a non-recourse loan in an IRA:
1. Identify an Investment Property
Research a real estate property that aligns with your goals. This can be a commercial or residential property, but some lenders favor properties with substantial income potential.
2. Create a Self-Directed IRA
First, create a self-directed IRA. A self-directed IRA allows you to invest in a wider range of assets, such as real estate, unlike conventional IRAs, which are often limited to stocks, bonds and mutual funds. Second, fund the account. You can contribute directly, rollover from an existing IRA or transfer from another provider. Work with a qualified intermediary as your IRA administrator or custodian. They will hold the money in escrow until everything is ready to close.
3. Find a Lender
Find a lender that offers non-recourse loans. They will assess the property, your eligibility and the down payment required. As mentioned, interest rates and down payments are generally higher. Down payments are typically 30% or more for non-recourse loans. Regular loans usually require 20%.
4. Apply for the Loan
Once you’ve identified the lender, you can apply for the loan. The lender will usually request an asset valuation and evaluate your creditworthiness. Be prepared to provide detailed information to facilitate the process. Loan underwriting can take several days to a few weeks, depending on the lender.
Your IRA custodian may facilitate the transaction to ensure a successful closing. Part of your IRA funds will be used as the down payment, while the non-recourse lender covers the rest, using the property you are investing in as the collateral.
5. Execute the Loan Agreement
Review the loan agreement, considering the principal, interest rate and repayment schedule. Ask questions or seek clarifications and request changes where necessary. Then, sign the contract if you’re satisfied with the terms.
6. Manage the Investment Property
The rental income from the property is usually deposited into the self-directed IRA. This arrangement enables you to repay the loan and build equity within your IRA. Expenses, including taxes, also pass through the IRA.
Benefits of Using a Non-Recourse Loan in Your Self-Directed IRA
Non-recourse loans have many benefits, such as:
- Obtain qualified non-recourse financing: Non-recourse loans allow you to invest in properties without being personally liable in the event of a default in payment. This feature limits your financial risks to the collateral.
- Increase your returns: You can control a much larger asset by only putting down a portion of the purchase price. This can lead to higher returns as you effectively leverage your IRA assets. For most IRA accounts, you may lack the capital to purchase high-cost properties and investments, and this is where the non-recourse loan can help you invest in things you otherwise couldn’t.
- Grow your IRA: By using a non-recourse loan, you can keep more cash in your account as the property generates rental income. This can be a great option as it gives you more liquidity in your retirement account in an emergency.
- No loan call option: With a recourse loan, the lender may call the loan anytime, which means they can demand that the entire loan be paid back immediately. With a non-recourse loan, a loan call is generally not an issue, as the only thing at risk is the collateral.
- Tax advantage: The property will be held in your IRA, and any income or gains it generates will go back into the retirement account. The upside is that all the gains are tax-deferred or tax-free, depending on your IRA type.
Downsides of Using a Non-Recourse Loan in your IRA
Using a non-recourse loan in your IRA has some potential downsides, including the following:
- Higher interest rates: Non-recourse loans usually have higher interest rates compared to recourse loans. This is because they are considered to be riskier for the lender.
- Large down payment requirements: Non-recourse loans often require substantial down payments, which can limit the capital available for other investments.
- Limited lender options: Only a limited number of lenders offer non-recourse loans, making it challenging to find suitable financing.
- Added costs: Some lenders charge origination fees on non-recourse loans, adding to your expenses.
Tax Implications of Non-Recourse Loans in an IRA
Investments can be tax-free or tax-deferred, depending on the type of IRA. However, using a non-recourse loan in an IRA can also trigger a Unrelated Business Taxable Income (UBTI) tax. Generally, if you finance the investment with a non-recourse loan, the income or gain is subject to tax. Consult a tax advisor to learn how the UBTI tax may apply, given your unique situation.
Alternative Investment Options
You can finance commercial and residential properties with non-recourse loans. Yet, it’s crucial to assess the value and conduct market analysis to determine the growth potential. Investing in alternative assets can help you reduce risks by providing exposure to different market dynamics. The professionals at Accuplan Benefits Services are ready to examine your situation and provide tailored guidance.
Finding the Right Non-Recourse Loan Provider
While non-recourse providers are limited, it’s still crucial to choose a lender with experience and an excellent track record. Accuplan Benefits Services streamlines the process for borrowers by helping them set up their self-directed IRAs and recommend lenders. You can leverage our established relationships and networks to find reputable non-recourse loan providers so you can access competitive financing options tailored to your investment needs.
Learn More From Accuplan Benefits Services
Are you ready to take control of your retirement investments? Non-recourse loans in your self-directed IRA can be a powerful tool for diversifying your portfolio and maximizing your returns while protecting your personal assets. At Accuplan Benefits Services, we help investors like you navigate the complexities of self-directed IRAs and non-recourse financing.
Don’t leave your financial future to chance! Contact us today to schedule a consultation with our knowledgeable team. Let us help you unlock the full potential of your retirement savings and explore the opportunities that non-recourse loans can offer.
Our information shouldn’t be relied upon for investment advice but simply for information and educational purposes only. It is not intended to provide, nor should it be relied upon for accounting, legal, tax or investment advice.
