It’s hard to keep up with the peaks and valleys the stock market has presented for the past few years. Up one day and down the next, but that’s just the name of the game. If the stock market has been your only vehicle for earning retirement income—it is time to take control and add a bit more diversity in your portfolio. You can do so by opening a self-directed retirement plan, which allows you to choose your own options from a very large pool of alternative investments.
Determining which areas to explore can be tough in an even tougher economic climate. Clients of Advanta IRA have been investing in different forms of real estate, foreign exchange markets, annuity settlements, and even within the filmmaking industry. Another investment vehicle that has gained popularity is hard money lending from a self-directed IRA.
What is a hard money loan?
In general terms, a hard money loan is one that involves real estate, is not dependent on the borrower’s credit score (because the collateral is the real estate itself) and typically draws a higher interest rate (8-15%) than a conventional loan. The loan is often structured with a low loan-to-value amount to protect the lender in the case of default and could include costly fees to the borrower for doing so.
Many hard money loans are desired by investors who purchase houses as rehab-and-flips. They buy the properties, make the repairs, then turn around and sell the houses for a profit. If these investors lack the capital to invest in real estate on their own, they often borrow from a hard money lender.
How do hard money loans work?
The loan amount is based on the quick-sale value of the property and includes the amount needed for repairs. The overage for repairs is held in escrow and withdrawn only as repairs are made.
For example, an investor has found a $40,000 house that needs $15,000 in repairs but he has no money. He approaches you and you look at the property and decide it is a good investment for your IRA. You two negotiate the terms of the loan and move forward. Your IRA transfers $55,000 to the closing attorney and he handles the purchase of the house, holding $15,000 in escrow for repairs. The attorney disburses the funds from that escrow account as the repairs are completed. Alternatively, your IRA could also simply loan the $55,000 directly to the borrower, depending on your comfort level.
Tips for hard money lenders
After deciding that hard money lending using a self-directed retirement plan is a good investment tool, there are a few key things to understand when determining which loans to make.
Make sure the property collateralizing the loan is one that you want your IRA to own if there is a foreclosure. Ask yourself, “Does this property have the potential to repay my IRA after it’s sold?” Also, remember that secured loans are permissible within an IRA as long as they are not made to a disqualified person or entity.
Examples of disqualified persons and entities include: the IRA owner, a spouse, parent, grandparent, etc. (lineal ascendants); a child or spouse of your child, and your grandchildren (lineal descendants); a business you or a disqualified person has more than 50 percent ownership of, is manager or owner of, or has a controlling interest in.
Negotiating terms of the loan largely depends on your comfort level as well as that of the borrower. Remember, Advanta IRA does not dictate the terms or conditions of the loan. A good person to consult in this matter would be a reputable real estate attorney or private mortgage broker who could help you navigate property values, fair interest rates, and terms that might be regulated by laws within your state. You will want to use this attorney or broker to transfer the funds and complete the loan process. This is much safer than simply writing a check from your IRA to the borrower because the attorney ensures your IRA is in the first mortgage position.
Hard money loans can be an easy way to diversify your portfolio and take control of your own investing funds and decisions. As a private lender, your IRA may be less exposed from a liability standpoint than if it owns real estate directly.
Minimize your investment risk by studying your market and becoming familiar with the ebb and flow of sales in your area. There are mortgage brokers who can help you find borrowers or you can find them on your own.
Remember that when using your IRA to work better for you, you are taking control of your own retirement decisions. You can’t possibly do that without performing quite a bit of due diligence and becoming something of an expert in the field in which you choose to branch out. The best way to ensure that your borrower is qualified is to consult a tax attorney, or contact Advanta IRA and we can explain the guidelines in more detail.
Advanta IRA is a self-directed retirement plan administrator that facilitates this type of investment. We provide exceptional personal service and free educational events to help increase your knowledge in diversifying your IRA. To learn more about educational opportunities in your area, please visit our event calendar.