Making Mortgage Loans with a Self-directed IRA

Buying and holding rental properties or rehabbing and flipping homes are popular investment strategies people use within their self-directed IRAs.  Another strategy gaining popularity is lending money through your IRA for mortgage loans.

Our story begins with Warren, who is a member of the Real Estate Investor Association (REIA).  Warren recently attended a seminar sponsored by Advanta.   He learned more about his self-directed IRA and potential real estate investments he could make to improve the wealth of his retirement portfolio.  Although rental opportunities and flips were covered topics, Warren found he was most interested in using his IRA to be a lender to people looking for mortgage financing.  The idea of having to be a landlord and being in charge of maintenance and repairs did not appeal to him.  But, if he were simply the lender, he would not have those responsibilities.   Also, his loan would be secured by a piece of real estate in case of default.

Through his networking at REIA events, Warren expressed his interest of being a lender to a few respected, local real estate investors.  Before long, several opportunities came his way.  Warren was careful to investigate and screen each person thoroughly before deciding to extend a loan.

Bill presented one opportunity to Warren in that he wanted a short-term loan.  Bill targeted a property he believed he could purchase, rehab, and sell within 12 months for a hefty profit.   Bill is looking for a $100,000 interest-only loan at eight percent interest, with a balloon payment in 12 months and a one percent fee for providing the loan.  Security for the loan will come with a first-position mortgage in the name of Warren’s IRA, should Bill default on the loan.

Tom has a different idea.  Tom currently owns a renovated house he wants to sell.  Unfortunately, the buyer does not qualify for the full amount needed, and could get only $100,000 for a traditional loan, leaving him $50,000 short of the full price for the house.  Tom suggests Warren lend $50,000 to the buyer at 12 percent interest for 10 years, with two points for providing the loan.  Security in this case is a second-position mortgage on the property, with the caveat being a much higher interest rate.

As a self-directed IRA administrator, Advanta cannot provide Warren any legal counsel or tax advice.  But, because real estate is in his area of expertise, Warren is able to assess the risk of each loan and accurately calculate the earning potential of each loan.  He decides he can safely finance both loans, and instructs Advanta to prepare the necessary documents for him to move forward.   Although unable to provide counsel through Warren’s decision-making process, Advanta is responsible for ensuring all loan documents are titled in the name of Warren’s self-directed IRA, trust deeds are secured, and documents are properly insured and recorded.  As the IRA is making the loan(s), the name of the IRA is listed as payee for the amounts of each loan.

In the opportunity presented by Bill, the return on investment to Warren’s IRA would be $9,000.  So his account receives a nine percent return on a 12 month investment.

Given the longer time frame and higher interest rate of Tom’s idea, the return on investment will be larger.  Please refer to the amortization table below to see the interest Warren’s IRA would earn over the 10 years of the investment.  Do not forget, the IRA also earned two points ($1,000) upon origination of the loan.

Year Interest Principal Balance
2010 $5,851.65 $2,756.60 $47,243.40
2011 $5,502.05 $3,106.21 $44,137.19
2012 $5,108.10 $3,500.15 $40,637.04
2013 $4,664.20 $3,944.06 $36,692.98
2014 $4,163.99 $4,444.27 $32,248.71
2015 $3,600.35 $5,007.91 $27,240.80
2016 $2,965.22 $5,643.04 $21,597.76
2017 $2,249.54 $6,358.72 $15,239.04
2018 $1,443.10 $7,165.16 $8,073.88
2019 $534.37 $8,073.88 $0.00
Total $36,082.57 $50,000.00

In these different cases, Warren’s IRA acts just like a bank.  Through Advanta, the IRA sends monies to the closings, receives monthly payments, and records a mortgage on each property.  Warren can’t believe how lucky he is!  His money is earning a decent return without a lot of work by him!