How to Lend Money from Your IRA
Yes, you can lend money from your retirement account. It’s called hard money lending, and it is trending. As someone who has done a few deals like this, I want to share what I have learned.
The Basics of Lending Money in Your IRA
Let me give you some of the basics. One of the reasons hard money or private lending is so popular is that it allows you, the lender, to set all the terms. That’s right; you set the amount to lend, the interest rate, the loan term, and almost anything you want. One of the other notable features is that these notes can be either secured or unsecured. Secured Notes are typically backed by collateral that will help avoid the loss of any principle. Secured Notes are always the preferred method when lending money. Unsecured Notes, while riskier, do appeal to a subset of investors with particular parameters and are allowed within your IRA.
What Do You Need to Know Before You Start Lending Money?
The first thing you need to know is that you will need to have a self-directed retirement account specializing in holding private notes. A self-directed IRA account is unique because it allows the IRA owner to hold private assets. Most brokerage houses do not allow this. Midland specializes in alternative investments, and notes are one of the most popular assets held.
Let me give you a typical example. Assume I have a traditional retirement account, and I have $100,000 in it. Now let’s say that I have found someone who would like to borrow $90,000 to purchase an investment property. The lendee puts $20,000 down, and I lend the difference. As I said above, I set the terms. I am going to charge them 10% for two years with two points. The property secures the note as collateral. All the interest payments go back to the IRA and are tax-free. These tax savings are a significant advantage of investing with a self-directed retirement account. (Please note your interest must not exceed state usury laws: do not be greedy!)
Let me change the deal a bit to benefit you, the lender. Instead of a flat interest rate, you could ask for a percentage of the profits when the deal closes. Instead of charging an interest rate of 10%, I would like 20% of the profits when you sell the property. This structure is relatively common. The other nice part of this deal is that the property is still put up as collateral to secure the money that you lent from your IRA.
There are multiple personal loan calculator tools. Here is a personal loan calculator tool that I find helpful.
What are the Benefits of Private Lending in your IRA?
As discussed above, one of the most significant benefits of private lending is that you set all of the terms. Included in these terms are the choice of the closing agent, surveyor, appraiser, and any other unique details about this investment. You are in complete control as the lender. Structures of these deals happen in different ways. It gives the investor flexibility based on the asset they are lending and the person they are lending to. The control given to the “lender” is a good reason that these deals are so popular.
So how do we wrap up this deal? Let’s assume that I loan the investor money to fix the property up, flip it, and sell it for $145,000. That would mean a $35,000 gain for them. When they sell the property, my note pays off with interest. All the money returns to my self-directed IRA at Midland. On to my next deal.
These deals require a lot of due diligence. However, because of the control you have as the lender, they can work smoothly as long as you clearly set the terms.
How to Find the Deals in Note Investing
The million-dollar question is, “how do I find the right deals, and whom do I lend to?” We are all looking for a great deal, and make profitable investments upfront by finding the right deal. It takes hard work. So while there is no one answer, I can offer you some sources which have worked for people who have done these types of deals.
4 Sources for Private Notes That I Have Found Over the Years
- Your fellow investors: Your investment circle is critical. Ask the people you work with or your neighbors if they know of any deals. They may also know about any properties that are being bought or sold.
- Mortgage Brokers: One of the best sources for finding private notes is talking to mortgage bankers or brokers. These professionals talk to individuals looking to borrow money all the time. And unfortunately, they cannot make every deal, so they know of individuals who either don’t qualify or don’t fit into the right pot to make a loan from their companies. These individuals can be great private lending clients. Typically they only need short-term money, and they are willing to pay a little extra in rate over the short term. Don’t be afraid to ask your favorite mortgage banker if he has turned anyone down recently.
- Builders: Builders are an excellent source for private lending deals. Typically small builders are looking to buy lots and build homes, and they need capital. They know that they can build a house in 6 to 12 months. These borrowers will pay a little extra in interest rates to borrow that money. Look at all the builders you know and start asking. Their needs might surprise you. Along these same lines, consider asking realtors. Realtors work with builders all the time, and sometimes they like putting a deal together because they ultimately get to sell the new house built.
- Investor Groups: There are many investor groups out there, and quite a few that only specialize in note investing. Search the internet, and I am sure you will find a note group not far from where you live. Just one of many places online to look is Meetup.com; they have hundreds of investing groups. The other great source is a local REIA group. These REIA groups consist of like-minded investors who have an ear to the ground and know about the deals.
What About Unsecured Loans?
One type of loan not discussed yet, Unsecured Loans. You can do Unsecured Loans with a self-directed IRA, and they are widespread. I want to put a word of caution out. When you loan unsecured money, there is no collateral. If the borrower decides not to repay the loan, there’s typically not much that you can do. I would make sure if you’re going to make an Unsecured Note that you have contacted your attorney and have the best documents that you can have to protect your investment.
Unsecured Notes are not uncommon. They are typically smaller loans than the secured deals I discussed above, and they are usually shorter-term loans.
If you would like additional information on how to set up a Midland account to begin private money lending within your retirement account, please feel free to call us anytime. We handle the administration of the private note, including receiving the payments. Private money lending can be extremely profitable if you know what you are doing and practice patience when looking for the right deal.
Before You Get Started
Before starting any investment deal, please talk to your tax or financial advisor to understand the impact of an investment on your financial situation. Midland is not a fiduciary and does not give specific investment advice. Please feel free to contact Midland Trust at 239-333-1032. Thank you and happy investing.
Author: Dave Owens, CPA, CES, is the President of Midland IRA and has been investing in real estate for over 20 years. His comments act as guidance to help investors understand how an investment deal works in the real world.