The IRA plays the part a bank normally would in extending loans to individuals or entities seeking to borrow money.
How it works:
- The IRA owner performs all due diligence and vets the borrower, decides interest rate, and negotiates a secured or non-secured loan
- Secured loans use property as collateral in case of default
- Unsecured loans typically carries higher interest rates as they are not backed by collateral
Advantages of private lending with a self-directed IRA:
- For the IRA owner: earnings flow into the IRA tax-free or tax-deferred; potential of higher returns than traditional investments
- For the borrower: receives cash faster than a typical lending institution may provide; avoids more stringent requirements of banks or mortgage companies
Different states may have varying rules that govern these types of investments structures. Be sure to consult with a trusted attorney or tax professional when using your self-directed IRA to invest in mortgages and notes.