Notes & Mortgages

Private Notes & Mortgages in a Self-Directed IRA

Private notes and mortgages as investments in a self-directed IRA earn passive income that helps you build tax-sheltered retirement wealth. Private lending is a popular strategy in the real estate realm. Your IRA extends loans just like a bank or other commercial lender does to people needing a mortgage loan or to real estate investors seeking capital to invest. However, your IRA can also provide personal loans to individuals for other purposes.

Private notes and mortgages in an IRA are alternative investment opportunities available only for self-directed retirement plans. Typical retirement plans restrict investments to more traditional assets like stocks, bonds, and mutual funds. Self-directed plans follow the same IRS rules as standard plans and provide the same opportunity to build tax-sheltered wealth. The only difference is that self-directed plans have access to a wide variety of alternative assets like private lending, real estate, precious metals, and private equity.

5 Simple Steps for Investing in Notes & Mortgages with Your Retirement Funds

You can get started investing in notes in mortgages using a self-directed IRA (SDIRA) in five simple steps. Your IRA earns interest on these notes and that income enjoys tax-sheltered status in the account, which helps you grow additional capital to invest. Listen now to learn how!

Key Advantages of Private Notes from an IRA

The advantages of private lending are just as beneficial to the borrower as the lender.

  • The borrower receives funds faster and with easier terms than with traditional lenders.
  • Your IRA earns monthly income on the interest and terms of the loan from the borrower, which helps you build critical income for your retirement.

Handshake while Handing Over the Keys after a private lending deal

Types of Private Loans

Personal loans to individuals

Borrowers have flexibility in how to use funds from a personal loan. Maybe they need the cash to help cover an unexpected expense, purchase a vehicle, or fund a European vacation.

Private mortgages to individuals

People use these funds to purchase homes instead of financing through a conventional mortgage lending institution. Private mortgages are often more flexible and have less stringent requirements for the borrower.

Real estate notes and loans to investors

A common practice for real estate investors is to use other people’s money to help finance an investment. These loans finance the purchase of investment property such as rehab real estate or rental property. Investors also purchase performing and non-performing real estate notes from other lenders and take over the notes/payments from borrowers.

How do Private Notes and Mortgages Work in an IRA?

Private Loans are IRA Assets

You do not take taxable distributions from the account to use as loans—your IRA makes loans with funds from the account. Income derived from interest and other terms of the loans is deposited directly into the IRA and enjoys the tax-advantaged status of the account.

As the IRA owner, you are responsible for performing due diligence, vetting borrowers, setting loan terms, and all other aspects involving using private lending in your IRA.

IRAs Cannot Make Loans to Disqualified Persons

The IRS has strict rules barring disqualified persons and entities from transacting with your IRA. Disqualified persons include you, your lineal ascendants (and their spouses), and your lineal descendants (and their spouses). Disqualified persons also include investment advisors, managers, fiduciaries, and anyone else providing service to your IRA. Corporations, partnerships, trusts, or estates in which disqualified persons have a 50 percent or greater interest are disqualified persons, as well.

If the borrower does not fall into one of the above categories, your IRA can lend money to them.

IRA Owners Perform Due Diligence on Loan Potential

As the IRA owner, you vet and approve all borrowers and conduct all other due diligence to protect your investment potential. This includes determining whether the borrower can potentially repay the loan in full. Your IRA can loan funds to your friends or strangers. The only people your plan can’t lend funds to are disqualified persons, including yourself, whom the IRS prohibits doing business with your IRA.

You Set the Private Loan Terms

IRA owners set the interest rates, monthly payment amounts, penalties for late payments, and the life of the loans.

Private mortgage loans have the same structures as conventional mortgages—you can assign a balloon payment, determine a fixed or adjustable interest rate, and secure the loan with collateral, which is typically the property purchased with the mortgage loan funds.

You Decide if Private Loans are Secured or Unsecured

Secured Notes are backed by collateral, like a house if your IRA holds a private mortgage. Unsecured notes are not backed by collateral but typically carry higher interest rates.

What Happens if a Borrower Defaults?

Suppose a borrower defaults on a private mortgage, and you used the home the mortgage funded to secure collateral. In that case, your IRA can take possession of the home by foreclosing on the property. You can keep the house as rental property or sell it to recoup the loan balance. Rental income and profit from a sale are deposited directly into your IRA, again enjoying the tax-sheltered status the account provides.

If an unsecured loan goes into default, your IRA has few options to recoup unpaid balances. You can take legal action against the borrower or turn the loan over to a collection agency to try and collect the debt for your IRA. The limited options to recoup an unpaid debt are the reason unsecured notes typically carry higher interest rates than secured notes.

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