Self-Directed IRA Expert: Horizon Trust BlogFebruary 23, 2022by horizontrustHow Do Non-Recourse Loans Work? Here’s a Guide.

Taking out a non-recourse loan for a rental property is a great compound interest investment to earn you money and protect your assets.

However, before you apply, you should first understand how non-recourse loans work and how they compare to recourse loans. 

Non-recourse loans are advantageous because the borrower has a level of protection not afforded by other methods. 

Regardless of the type of loan, it’s still possible to seize the collateral if you default on the repayment agreement. 

Because of how these loans differ, it’s important that you know how a non-recourse loan works and how you can use it to invest. 

 

How Do Non-recourse Loans Differ from Recourse Loans?

 

A recourse loan allows the lender to seek additional assets from any borrower who ends up defaulting on the loan. 

Let’s say that a borrower obtains a recourse loan when applying for a mortgage. If the collateral value is lower than the debt owed, the lender can go after the borrower’s other assets to cover the remaining debt. 

As for a non-recourse loan, the lender can only seize the collateral specified within the final loan agreement. 

The lender will not seek full recourse even if the debt is valued higher than the remaining collateral. For investors who want to protect their assets if their investment defaults, a non-recourse loan is an excellent option. 

Nevertheless, because of non-recourse loans limitations, most banks and similar financial institutions don’t offer non-recourse loans. 

In cases of default regarding a non-recourse loan, the lender may be unable to recoup all of their losses via the assigned collateral, which essentially means that the lender would be taking on more risk when providing these types of loans. 

So if you’re looking for a non-recourse loan, you may have to look through a specialized lender or fill out a particular application with your bank.

However, if you’re looking to borrow money and want to obtain a non-recourse loan, this option has some downsides which should be noted. 

Since lenders are unable to seize additional assets, they will charge higher interest rates, which means that the monthly payments throughout the loan duration will be higher. 

Fortunately, much of this can be avoided if the borrower has a high credit score and fantastic credit history. 

 


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How Do You Qualify for a Non-recourse Loan?

 

If you want to qualify for non-recourse financing, it’s first important to understand that the lender is taking on most of the risk. 

As such, the terms of your loan will likely be stricter compared to the terms of recourse loans. 

In most cases, lenders and investors only provide non-recourse loans to worthy borrowers. It’s also likely that this type of loan can only be sought for specific property types. 

If you want to be certain that you qualify for a non-recourse loan, you must have:

  • Strong personal finances
  • A high credit score
  • A debt service coverage ratio of 1.25 or better
  • A steady and consistent source of income

It’s also important that the collateral that’s used for the loan is:

  • Located within the U.S.
  • Not your primary residence
  • Constructed after 1940
  • Has a roof that isn’t directly shared by another property

The main benefit of seeking this loan is that the rest of your personal assets and finances won’t be tied to the loan in the form of collateral. 

 

Do You Have to Pay it Back?

 

Even though a non-recourse loan is more beneficial for the borrower, you will still need to pay back any debt that you owe. 

While the lender will not seize any of your additional assets if you default, you will lose the primary asset. In addition, this default will also be placed on your record, which will significantly hurt your credit score and credit history. 

 

Can You Use Your IRA to Invest in Non-Recourse Loans?

 

If you’re looking at investing in real estate by seeking a non-recourse loan, specific rules are associated with purchasing real estate with your IRA account. 

If you want to use your self-directed IRA to invest in real estate with the help of a non-recourse loan, the loan itself will be under the name of the IRA as opposed to the IRA owner. 

If the IRA ends up defaulting on the loan, the lender can obtain the property in the IRA that was used as collateral. 

Any additional assets owned by the account holder or IRA cannot be directly pursued, making this an ideal investment opportunity for IRA holders. 

If you happen to make a traditional investment with a non-recourse loan, your loan payments will come directly out of your IRA account. 

Because of the lender’s risk with this type of loan, the required down payment may be as high as 30-40%. However, each lender differs, which is why you should do your due diligence when searching for the best loan terms. 

If you’re thinking about investing in a property, and want to protect your assets if you do default, a non-recourse loan may be right for you. 

Best of all, non-recourse loans can be tied to a self-direct IRA account and another tool to help you build out your real estate portfolio.

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