How does a non-recourse loan work?

4 Replies

How does a non-recourse loan work with an IRA or Solo 401K? I understand that the bank requires a larger down payment than for a normal mortgage because they can't recover money from the IRA in the event of a foreclosure.

But I don't see how that protects the bank. Say my IRA puts $40K down and the bank $60K on a $100K property. What happens if I default on the loan, and the bank is stuck with the property? Since they can't keep the IRA money, would they have to refund that $40k to my IRA? That would mean they are into the house for a total of $100k, defeating the purpose of me (the IRA) putting any money down at all.

I'm sure I'm missing something obvious.

David

I think you're confusing where the $40k goes. The bank is only lending $60k in the example above. The balance between the lesser of the appraised value or the purchase price is the bank's cushion if the event you default. There would be no "refund" of the $40k in your scenario. The money would be at risk and the lender would have access to the collateral (the property) without the opportunity to go after some deficiency judgement for the balance if the language in the loan and your actions are normal for a non-recourse note.

Note that you have to have a non-recourse note to do what you're trying to do because a personal guarantee would be considered an outside benefit to your SDIRA. This topic has been discussed 100 or more times on BP. Try doing some searches and digging up some of those threads. The general consensus is that this is a poor use of SDIRA funds relative to other options.

That makes sense now. So you can definitely lose the entire amount the IRA invested in the house, but the bank can't go above and beyond that.

Do you mean that buying real estate in general is a poor use of SDIRA funds? I have spent some time reading the forums here, but it sounds like I will have to dig deeper. This is the first I've heard this.

Thanks for the reply.

David

@David B.

if you default on the loan for a property owned by your IRA or 401k, the bank will take the property only, they have no recourse against you personally or against any other assets that you may have in our IRA or 401k. That is why the loan called 'non-recourse'. In your example you would loose your down-payment of $40K, and the bank would now own the property that they have $60K interest in but it is worth $100K.

Some think that buying real estate inside of an IRA is not as beneficial as say investing into a real estate note (especially if you use leverage inside of your IRA and portion of the income will be subject to UDFI tax).

However, I would not just make a blank statement like that across the board. It all depends on your personal situation, goals and a particular deal that you are investing in. I personally own notes and long term buy and hold rental (financed) inside of my Roth 401k.

Unlike SD IRA, Solo 401k is exempt from UDFI tax on leveraged real estate. and because I'm doing it in a tax-free environment, this makes it very powerful. Timing is also very important when you invest.

So the bottom line is educate your self, be aware of all the options available to you, consult with the experts and do what's best for you.

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