As we shared in this post about lending money through a self-directed IRA, making loans in this manner can be very profitable. It’s also a great way to diversity your portfolio.
There are many creditworthy people out there who would be disqualified for lending through a traditional bank loan. Those who are self-employed or someone whose income is based on commissions are two examples. Since banks have tightened up guidelines, private lending has grown in popularity in recent years.
One case study we’d like to share involves providing a loan to a large, local builder. The builder is offering promissory notes to help fund the development of a new subdivision. Leigh Adams decides to lend $50,000 from her traditional self-directed IRA to the builder. She feels confident that this is a wise investment.
We know that IRAs can lend money, either secured with an asset such as real estate or a car or unsecured with no collateral. Leigh already has an account with IRA Innovations that has $75,000.
Here are the steps she would complete to fund the loan.
Leigh receives a promissory note from the builder. The lender is Leigh’s IRA, and the note should show this as: IRA Innovations, Inc FBO Leigh Adams IRA
- She completes a buy direction letter with all the information about the note, including the face value, the interest rate, frequency of payments, and duration of the loan. She then sends the buy direction letter with the promissory note to IRA Innovations for processing.
- We send the money to the builder.
- Each month the builder sends the loan payment to IRA Innovations to be deposited into Leigh’s account until the loan is paid off.
This is a fairly simple case study, and the outcome is good for all those involved.
In another case study that’s a little more involved, Sue decides to use her IRA to lend money to a rehabber. Sue belongs to a local real estate investment club. She wants to offer loans to people who buy and fix foreclosures. With $85,000 in her IRA, she thinks she would realize a better return if she did private lending from her IRA. So Sue turns her IRA into a lender.
Sam the rehabber is looking for a loan, and Sue learns about him and his need for funding. Sue conducts due diligence on Sam and the property with all due diligence costs being paid from her IRA. Sue decides she will offer to lend Sam $80,000.
Sue comes up with her loan terms:
Loan amount: $80,000
- Interest rate: 12%
- 2 points: 1 at origination and 1 at payoff
- Maturity is 2 years from issuance
- Monthly payment: $800.00
Sue’s attorney prepares the note and mortgage, and all documents are sent to IRA Innovations.
Six months later, Sam has rehabbed the property and is ready to sell. He requests the payoff amount. Sue is the loan servicer and provides a payoff letter. The payoff letter is sent to the title company handling the close. Here are the results:
Repaid principal: $80,000
- Payments: $4,800
- 2 points: $1,600
- Total earnings: $6,400
- Return on investment: $6,400/$80,000 x 2 or 16%
As you can see, Sue’s goal of realizing better returns through private lending has come true with significant return on her investment.
While we hope our blog is interesting and informative, we do want to note a disclaimer that IRA Innovations does not give investment advice. It is up to you to invest in what you know best, what you feel most comfortable with and what matches your financial needs.
IRA Innovations provides self-directed retirement account administration and education. As the experts when it comes to “alternative” investments including private equity, they can provide the necessary tools and information to get started with a real estate IRA.