Self-directed retirement accounts (SDRAs) can be a powerful tool for real estate investing, allowing you to use your retirement funds to purchase properties.
With an SDRA, such as a Self-Directed Individual Retirement Account (SDIRA) or a Self-Directed 401(k), you can use your retirement savings as a down payment and secure non-recourse loans from portfolio or private lenders.
Additionally, you can structure deals through an LLC with a partner, providing more flexibility and potentially lowering your down payment.
Let’s explore how this strategy works.
Eligibility/Requirements
To use your self-directed retirement account for real estate investing, you need a qualifying account, such as a Self-Directed IRA or Self-Directed 401(k).
These accounts allow you to invest in a wide range of assets, including real estate.
In many cases you’ll choose to work with a custodian or firm that specializes in SDRAs, as there are strict rules regarding prohibited transactions and who can use the property.
However, there are some companies set up to help give you full checkbook access to your self-directed retirement accounts.
Owner-Occupancy Requirement
You cannot use SDRAs to purchase owner-occupied properties.
The IRS prohibits you from living in or personally benefiting from any property owned by your self-directed retirement account.
These properties must be purely for investment purposes.
Down Payment
When using your SDRA, you can finance properties in two primary ways:
- Non-Recourse Loan – Many portfolio lenders—and friends and family acting as private lenders—offer non-recourse loans to SDRAs, meaning the loan is secured solely by the property. You can expect to make a larger down payment, typically 35% or more, when using a non-recourse loan with a portfolio lender. Of course, your private lender may not require any down payment at all. The lender cannot pursue other assets of the self-directed retirement account if the loan defaults which is why portfolio lenders tend to require a larger cushion of equity to protect themselves.
- LLC with Partner – Another common strategy is to invest your retirement funds into an LLC with a partner who signs for and provides the loan. In this case, you might be able to make a lower down payment (around 20%) because the loan is recourse to the partner or other loan signer, not the retirement account.
Loan-to-Value (LTV) Ratio
LTV ratios for SDRAs depend on the type of loan you secure:
- Non-Recourse Loan – Non-recourse loans generally offer an LTV of around 60-65%, meaning you need to provide at least 35-40% of the property’s purchase price as a down payment. This is due to the higher risk the lender takes on without the option of pursuing other assets.
- LLC with Partner – If you invest through an LLC with a partner and take a recourse loan, you can often secure a higher LTV of 75-80%, allowing for a lower down payment.
Interest Rates
Interest rates for SDRA loans typically exceed those of traditional loans, particularly for non-recourse options. This difference is notable, with rates usually 1-3% higher than standard portfolio loans.
Non-recourse loan rates are influenced by factors such as the specific lender and current market conditions. However, there’s potential for more favorable rates when utilizing an LLC with a partner.
In this latter scenario, the interest rate is determined based on the creditworthiness of the loan signer, which can lead to more competitive terms.
Amortization Period
Amortization periods for SDRA loans generally mirror those of conventional loans, but come with certain restrictions. Non-recourse loans typically feature 20-30 year amortization periods.
However, the actual loan term is often shorter, ranging from five to 10 years, with a balloon payment due at the end. This structure is common in SDRA financing.
In contrast, recourse loans obtained through an LLC structure may offer more flexibility. These loans can potentially provide longer terms and more favorable amortization schedules, giving investors additional options to consider.
Private Mortgage Insurance (PMI)
PMI is not typically applicable to SDRA loans. Since you are using retirement funds and non-recourse loans require a large down payment, PMI is not required by lenders.
Loan Limits
Loan limits for Self-Directed Retirement Accounts (SDRAs) are flexible and primarily determined by the property’s value and your account’s cash reserves. There are no set limits imposed by regulations.
Instead, the loan amount is typically capped by the lender’s Loan-to-Value (LTV) guidelines. This means that the more funds you have in your retirement account, the more you can potentially invest in real estate through your SDRA.
It’s worth noting that non-recourse loans, which are common with SDRAs, may have stricter limits. This is due to the increased risk the lender takes on with these types of loans.
Number of Loans Allowed
There is no formal limit on the number of loans your SDRA can take. You can continue to invest in multiple properties as long as your SDRA has sufficient funds for down payments and reserves, and you can find lenders willing to issue non-recourse loans.
Seller Concessions
Seller concessions can be used when purchasing a property with a self-directed retirement account, but they must be handled carefully.
Since the property is being bought by the retirement account, the concessions must benefit the account, not you personally. Concessions can be applied to reduce closing costs or fund property improvements, as long as the benefits flow solely to the retirement account.
Waiting Period After Major Financial Events
Non-recourse lenders for self-directed retirement accounts may not enforce strict waiting periods after financial setbacks like bankruptcy or foreclosure. This is because these loans are secured solely by the property, not by personal guarantees.
However, your credit history can still impact your loan terms. If you’ve experienced major financial events in the past, you might face higher interest rates on your non-recourse loan.
Refinancing Rules
Refinancing your SDRA loan can be complex, but there are options:
- Rate/Term Refinance – You can refinance your non-recourse loan to secure a lower interest rate or better terms. However, since the loan must remain non-recourse, your options may be limited compared to conventional loans.
- Cash-Out Refinance – Cash-out refinancing is generally not allowed with non-recourse loans due to the strict guidelines on borrowing within retirement accounts.
- Recast – Recasting is not typically offered for SDRA loans, as these loans are structured differently from conventional financing.
Property Types Eligible
Self-Directed Retirement Accounts (SDRAs) offer investors a wide range of property options. These accounts can be used to invest in various real estate types, including single-family homes, condos, townhomes, multi-family properties, commercial real estate, and even undeveloped land.
However, it’s crucial to note that there are strict rules governing the use of these properties. The property purchased through an SDRA cannot be owner-occupied or used by you or any “disqualified persons,” which includes family members, for personal benefit. These investments must be purely for investment purposes.
Special Loan Features
Borrowing from your SDRA comes with unique features:
- Non-Recourse Loans – The loan is secured solely by the property, and the lender cannot pursue other assets if the loan defaults. However, this results in higher down payments and interest rates.
- LLC with Partner – By partnering with another investor and using an LLC, you can lower your down payment and secure a recourse loan to the partner, offering more flexibility.
- Buying In Entities – SDRAs can invest in real estate through LLCs, provided the account owns the LLC. This strategy may offer additional protection, privacy and flexibility, especially if working with a partner.
Approval and Underwriting Process
The approval process for SDRA loans is more straightforward than traditional loans, focusing primarily on the property and the loan-to-value ratio. Since non-recourse loans don’t involve personal guarantees, the lender is more concerned with the property’s income potential and your retirement account’s reserves.
Risks and Considerations
There are unique risks when borrowing from an SDRA:
- Strict IRS Rules – SDRAs are subject to stringent IRS guidelines, and violating them can result in penalties or disqualification of your account. It’s crucial to work with a knowledgeable custodian to avoid prohibited transactions.
- Higher Down Payments and Rates – Non-recourse loans come with higher down payments and interest rates, which can limit your purchasing power compared to conventional financing.