We are all familiar with traditional mortgages. There are fixed rate and adjustable rate loan modifications typically running 30 years. Most of these are sold to Fannie Mae or Freddie Mac or are backed by FHA or VA. The requirements of these are fairly standard and the application process quite painful. The applicant and the home loan must fit into the parameters set by these organizations so the loan can be packaged and sold to Wall Street. One set of rules applies to owner occupied homes and another to investment properties. Most importantly, at closing you are signing saying you will pay back the loan and if you do not, the bank can take back the property AND come after you for any deficiency.
A smoothly functioning system except when the borrower is not a “person.”
WHAT DOES NON-RECOURSE MEAN
If you purchase a property in a LLC or in a self directed SDIRA, the standard loans are not available to you because the entity is the owner and not you. Thus the lender has no “recourse” or no way to go after you personally if you default. The “veil” of the LLC or SDIRA protects the individual from any liability beyond the asset itself. (While these loans work in a LLC or SDIRA, I will focus on the SDIRA for the remainder of the article.)
So what to do if you want to leverage your real estate purchase in a SDIRA? Secure a loan from a non-recourse lender. In my research I have come across only a handful of lenders that lend in all 50 states. Recently, I bought a property in a SDIRA and used North American Savings Bank out of Kansas City. The process was simple and streamlined compared to the traditional mortgage process. (My loan was handled professionally by Jason Zook, jzook@nasb.com and Nick Allen, nallen@NASB.com)
It all started with the application. It was on 2 pages and if not for the large headers could have been on 1 page.
THE APPLICATION PROCESS
Here is what they asked: the address of the property being purchased, size of the home, purchase price, anticipated rent, my name, address, contact info, SSN, and the account numbers and balances of my IRA accounts.
Here is what I had to provide: Sales contract, property management agreement, copy of my drivers license, insurance information and IRA statements.
Note what they did NOT ask for: Name of employer, occupation, income, list of debts, copies of bank statements and all of the 1000s of other things a traditional lender requires.
Why so little? Because their only “recourse” in the event of default is the property. You don’t really matter. They did run credit but I was told that unless there was a string of bad credit decisions, the report really did not matter. The loan decision is not credit score based or based on debt to income ratio. They just want to make sure you are not a deadbeat.
Of course, they require an appraisal which will include an appraisal of value of the home and an estimate of the monthly rent. They want to make sure the property – not you – qualifies for the loan program.
PROPERTY QUALIFICATIONS
Non-recourse loans are for income producing properties only. There are other reasons people buy investment property. Fix and flip investors, land speculators and others must pay cash or find other lending sources. For a property to qualify, the general guidelines are
*Down payment of 30% to 40%
*Rent must exceed expense by at least 25%. If your PITI plus HOA/condo fee and management fee is $1000 per month, the appraiser must come in with a value of at least $1250 for the rent.
*Reserves in the IRA for potential vacancies and the inevitable repair expenses. The amount varies by lender. For most, the reserves do not need to be in your SDIRA but can be in another IRA. Many people keep a stock trading account at a place like Schwab or Ameritrade and keep just enough in their SDIRA to handle the purchase and a few months of mortgage payments.
*Minimum loans are usually $50,000
*Home must be in relatively good condition. It can need updating but a total remodel may be problematic.
RATES AND TERMS
With a streamlined process and limited recourse by the lender, there must be a catch. Well, not really a catch but a bit of reality that verifies nothing is free.
The maximum loan term is 25 years but most are 20 years. You can modify the term from 10 years on up to 20 or 25.
Down payments are a minimum of 30% but 40% is usually required to get the maximum loan term.
Rates are higher than traditional rates. I don’t have a problem with that as the risk is greater to the lender since they have no recourse against you personally.
Recently, 30 year fixed rates for non IRA investment loans were around 4.5%. At the same time, a non-recourse fixed rate with a 10 year amortization was at 5.25% and for a 20 year amortization, the rate was 6.25%. There were 3/1 ARMS at 4.25% amortized over 10 to 25 years and 5/1 ARMS at 4.625. I have noticed that while traditional mortgage rates change a little daily, the non-recourse rates tend to stay the same until there are significant changes in the underlying market. Note, these rates are only for sample purpose and intended to give you an idea of the difference between traditional mortgage rates and non-recourse rates. There is no guarantee these rates will exist when you go to borrow.
The higher rates and the shorter term do make it harder find a property that cash flows at the desired level but such properties do exist. If you are interested in starting a search give me a call.
If your target area is in Northern Virginia, I will be happy to help you. If your target is elsewhere in the US, call me anyway. I will be able to find a Realtor in that market who is an investment expert. It is important to have a knowledgeable Realtor when pursing property in a SDIRA. Not only do you need to find the right property but you need to make sure the process stays within IRS guidelines. Let me help point you in the right direction.
