What Is A Non-recourse Loan?
When most real estate investors are getting started, they don’t have hard money to invest in their deals. However, even though you might not have the cash in the bank to pay for your investment, there are still financing options that you can leverage. If you are looking for a loan for an investment opportunity, consider borrowing money from private lenders by way of a non-recourse loan.
Let’s first define the difference between Recourse and Non-Recourse financing.
Recourse financing provides lenders full recourse to the personal assets and/or cash flow of the individual borrower for repayment of the loan in the case of default. If the borrower fails to pay his or her lenders according to the agreement (which comes in the form of a promissory note that is secured by the asset through a mortgage or deed of trust), the lenders will then have recourse to the assets and revenue of the borrower without limitation.
Non-recourse financing is a loan that doesn’t allow the creditor to come after the borrower, and ideally, you want to structure the loan agreement so that the lender cannot come after any of your business assets either. So, for example, if I borrow money from you, or my company borrows money from you, and I say I want it nonrecourse, you can’t come after my personal assets or business assets. If I default, you can only go have recourse or go after the asset that secures the loan. Another example may be that I give you the title to my car. You can go after my car and repossess it, but you can’t come after me personally if my car doesn’t satisfy the loan when I default. That is a non-recourse loan.
In a typical loan, you might see the borrower guarantee the loan. But in a nonrecourse loan, the bank only has a trust deed against the property and they can’t come after the borrower themselves. The trust deed or lien against the property is their only recourse. It’s nonrecourse against the person and as I stated previously, in a perfect world you wouldn’t want to risk the cash or assets that your business owns either. In a true non-recourse situation, the lender’s only recourse is the asset that was purchased with the funds provided by the lender.
One particular situation you might see in real estate is with IRAs or retirement plans. You might have an IRA or self-directed retirement plan that sets up an LLC and buys real estate that is building a portfolio of cash flowing properties for the IRA. You see, an IRA can own real estate and have a loan against that real estate.
Most institutional non-recourse lenders are going to ask for about 40 percent down and want to see about a 10 percent cash reserve inside the LLC. That’s a total of 50 percent cash brought to the deal by you as the borrower. Let’s say that you have $100,000 in your IRA. You now have the ability to buy two cash-flowing assets worth $100,000 each with non-recourse loans ($50k each) versus one asset with your $100,000 cash from your IRA. If you default on either of these loans, the lender can only come after the assets and not you personally. The default may show up in public records if the lender has to sue to take possession of the asset, but it will never show up on your credit report because you did not personally guarantee the loan.
How does any of this pertain to Subject-To Real Estate Investing?
Many real estate investors who buy houses using Subject-To financing oftentimes run into a very common situation where a property needs some renovations or updating, but the investor might not have the funds needed to make those repairs and get the property into the type of condition that would attract a top-notch tenant or owner-financed buyer. This is where non-recourse, private lending comes into play.
It’s fairly common for real estate investors to branch outside of traditional lending programs and instead use private money to finance all or part of an investment property. Using private funds to invest in real estate can be beneficial for both the investor and the private lender allowing the active investor to purchase a new investment property while the private lender receives a return on investment.
So, why not bring in a private lender to fund your rehab costs? This is an ideal scenario that allows the private lender to invest smaller sums of money into asset-backed investments and earn great returns on their capital. Your lender will need to take a 2nd lien position subordinate to the primary lender, but they are also investing much smaller sums of money into the deal and they’ll still have the ability to foreclose in case of default.
For the investor, it is an opportunity to put a deal together will little to no money out of pocket and earn monthly cash flow from the property when it’s leased to a tenant or sold to an owner-financed buyer. Of course, the deal has to make sense financially and it MUST cash flow, but if you have virtually nothing out of pocket in the deal and the property has positive cash flow, why not get private money into play?