Private lending investments offer many different avenues to earn income. Investors can choose to extend money to individuals for mortgages or other things (like a car or a boat). They can also loan money to businesses and other entities in much the same way a bank or other lending institution would when loaning funds. Your self-directed retirement plan can also extend loans in this manner and earn tax-sheltered income for your retirement.
Many self-directed IRA owners are familiar with private lending transactions and choose to use these assets to grow retirement income. Successful investments produce a pretty darn good return in comparison to what you’d earn on something like a mutual fund or a CD at today’s paltry interest rates.
How Private Lending Works in an IRA
When you use self-directed retirement funds to invest in private lending options, your account is obviously the lender, not you personally. However, as the account owner, you are responsible for vetting the borrower. You also get to set the terms of the loan, such as the length and interest rate.
Secured loans are backed by collateral (such as a house). Unsecured loans are not backed by collateral, but typically carry a higher interest rate than secured loans do.
Three Types of Options Your IRA Can Invest In
- Private mortgages: In the right circumstances, these options have the potential to present significant benefits to your retirement plan. For example, say you have a friend who is looking to buy a home but for some reason can’t get approved for funding from lending institutions. While you should be cognizant of why they are being denied funding from these institutions, if you perform your own due diligence and determine you are comfortable—your IRA can be their bank and help them secure their home. Here, you may decide to charge a 5-6% interest rate and require the home as collateral. Remember, the terms of the loan are totally at your discretion. Your retirement plan earns income on the interest or in case of default on the loan, can take possession of the property and sell it for a profit.
- Mortgage down-payments: Often, home buyers may be approved for a mortgage by a bank, but need a helping hand coming up with the required down-payment. In the average scenario, again, this may be a friend or relative that you feel comfortable dealing with. Your IRA can lend the funds and you can choose to make this note unsecured, if you wish, or stand in line behind the bank as a lien-holder.
- Loan funds to another investor: These transactions are not uncommon, especially for those who are involved in investing clubs and have solid networks of peers they feel they can trust. Your IRA can play the part a bank would here, too, and loan funds to an individual or an entity that needs capital. Like all other lending transactions you’re responsible for performing all due diligence to fully evaluate the opportunity. You have the freedom to be as picky and choosy as you please and can set your terms as strictly as you wish.
Private lending investments have the potential to present a win-win situation for both the borrower and your retirement plan. However, never forget there is risk involved in any investing situation. Loaning money from retirement funds sounds easy—but a wrong move can be painful, too! So, become knowledgeable in this realm and don’t hesitate to use professional resources to assist you. You’ll never regret taking precautionary steps to avoid fraud and operate in compliance with IRS regulations to protect your assets and your future.
Advanta IRA is a self-directed IRA administrator serving clients across the nation who choose private lending assets to build retirement wealth. If you have questions about this article, please contact us.