How to Use Your IRA to Buy Real Estate with No Money Down
We have done this.
I am very cautious in recommending any unique financial strategies unless I have successfully executed them myself. So, I need to say, right from the beginning, that this is a strategy for real estate investing the my wife and I used to buy our first two rental properties with no money down and leaving our IRAs completely intact when all was said and done. It worked very well for us and hopefully you will be able to add it to your real estate investing tool box.
This is not a self-directed IRA.
To be clear, this strategy does not entail using a "self-directed IRA" in which your real estate is bought inside your IRA. A self-directed IRA can be a viable option but it includes higher fees, extensive record-keeping, and usually a third party self-directed IRA administrator to facilitate the investment. The strategy we will discuss here is cleaner, more flexible, and less costly.
The 60-day indirect IRA rollover rule.
There is a rule in the IRS code that allows for something called an "indirect IRA rollover". This is when the funds from an IRA, or another tax-advantaged retirement account (401k, etc.), can be withdrawn and put into your checking account. The funds then must be placed into another IRA or tax-advantaged retirement account within 60 days. The 60 day time frame is very strict and must be met in order to avoid making the funds taxable or incurring a penalty for early withdrawal (if under the age of 59.5). This type of indirect rollover can only be done once every 12 months.
Identify your investment property.
Now, here I am assuming that you have educated yourself regarding real estate investing. If you haven't, you need to do that before jumping into a property, especially with a strategy like this. Www.biggerpockets.com is probably the best resource for this online (also check out the Biggerpockets podcast and the Real Estate Guys Radio podcast). You will need to identify a property that will cashflow even if it is 100% financed. That means that the rents need to cover all mortgages and loans, maintenance, vacancies, and other costs and still leave you some cash left over each month. Since this property is going to be highly leveraged, you need to lower your risk by ensuring you have a solid, cashflowing property that can pay for itself.
You will use your IRA funds as the downpayment to purchase the property. Once the property is purchased and the mortgage is in place you will then obtain a separate loan, or loans, to pay back the the funds to your IRA within the 60-day time period.
Let's use an example to walk through it. Say you have an IRA with $63,000 in it and you are looking to purchase an investment property for $200,000. Let's also assume that the closing costs for the purchase are $5,000. Most investor, non-owner-occupied loans, will require about 25% down. So, you will then withdraw $55,000 from your IRA to cover the downpayment and closing costs. Once the purchase transaction is complete you will then need to obtain a loan or loans in the amount of $55,000 and pay those funds back into your IRA within 60 days of withdrawal to avoid taxes and penalties.
Remember, it is very important in your initial analysis of the property to have already identified a source for these funds to pay the IRA back and you must ensure that the property will cashflow taking into account these additional loan payments.
Sources for the additional loan(s) to pay the IRA back.
Some good sources of funds to pay pack the IRA include a home equity line of credit, a personal line of credit from a bank or other financial institution, loan from family or friends (However, don't be naive in how loans between family and friends can change relationship dynamics. I personally avoid this as relationships are far more important to me than financial success), or many other creative sources.
These funds can come from nearly anywhere since you are obtaining them after the transaction is already closed and they are not taken into account to qualify for the main mortgage and purchase.
Optimize deeper: Balance transfer checks.
In both of our investment property purchases using this strategy we actually used balance transfer checks from credit cards that we don't use on a regular basis. This is a unique strategy in itself. We are huge fans of travel hacking through credit cards and have been diligent to build up nearly $300,000 in available credit simply in the credit cards that we have. We constantly get balance transfer offers checks in the mail that allow us to write checks directly on these credit cards accounts usually offering an interest rate of 2-3% for a 12-18 month promo period. So, these are the funds that we use to pay back the IRA. We then aggressively pay down these balances during the promo period using the extra cashflow from the investment property. At the end of the promo period, the balances have either been paid off or we simply pay the balances off with a new balance transfer check from another card and continue to pay that one down at the very low interest rate as well.
A few notes on using this balance transfer strategy.
First, you need to know that when your promo period of 12-18 months is up, there is no guarantee that their will be other balance transfer offers available. During the recession, these types of offers pretty much dried up completely. So you need to have a plan for what to do if this happens. That is one reason why we pay them down very aggressively with the additional cashflow from the property.
Second, always make your payments on time! Using credit cards in this way can work well but you need to stay organized, not miss payments, and track when you promo period ends so you don't bump up to an astronomical interest rate of 20% or more.
And third, use business card balance transfer checks when possible. This is an incredible piece of knowledge that took me a while to figure out. Business cards from some banks do not show up on your personal credit report. Chase bank is one that we have used but there are others. The benefit of this is that if you still have a balance on this card when going to purchase your next property, that balance does not show up when your lender pulls your personal credit report to qualify for the loan, which means the payment on the card does not count against your debt to income ratio. This may not matter if you have plenty of income. However, if you are right on the line, this may make the difference between buying another property or having to wait a couple years until your debt is paid down or your income is higher. Also, carrying these balances on a business card that is not reported on your personal credit report will keep it from impacting your personal credit score.
Additional thoughts and cautions.
One thing to note is that you may be able to skip this IRA strategy altogether and simply take a separate loan out right from the beginning to cover the 25% downpayment and closing costs (like a home equity line of credit or balance transfer checks). However, your lender will need to verify where those funds are coming from and take those additional payments into account when you are qualifying for their mortgage. You may be fine if you have enough income, but it may push you beyond their debt to income ratio maximums, which results in them not approving you for the loan. The benefit of using the IRA funds initially is that the mortgage lender looks at those funds like cash. Then, by placing the additional loan(s) after the transaction is closed it ensures that the payments on the new loans are not used to disqualify you from getting the main mortgage.
It's important to not draw the IRA funds out until you need them, usually just a week or two before closing on the property, since the 60-day clock starts ticking as soon as you draw them out.
This 60-day indirect rollover can only be done once every 12 months, but that is per person. So, in the case of my wife and I, we are each able to do this once every 12 months, which really accelerates your real estate investing.
You need to be very self aware of your money habits. This strategy is not for someone who is not good at managing their payments or credit. We have $300,000 in available credit from our credit cards because we have systematically opened cards to obtain the signup bonuses, have never been late on a payment, and always pay our cards off every month other than in the long-term balance transfer instances for real estate investing. Your credit score and credit history is very, very valuable and should be treated as such.
The outcome is the best part.
Once you have completed this strategy what you are left with is truly amazing. You now have a property that you have no money tied up in, which is providing you an infinite rate of return in cashflow, mortgage, appreciation, and depreciation expense. Also, you still have your IRA, fully intact, which you can continue to contribute to each year and use once every 12 months for the same purpose!
- Mr. Optimized Life