Private Lending Using a Self Directed IRA

If you like the idea of investing your money passively, with little risk, becoming a private lender is one of the best ways to go about it.

If you lend that money as part of a Self-Directed IRA (SDIRA — Self-Directed Individual Retirement Account), you are entitled to tax-free profits. Here’s what you need to know. 

What Exactly Is a Self-Directed IRA?

The name refers to a type of IRA which allows a broader scope of investments than just traditional assets such as stocks. Alternative investments that can be invested into an SDIRA include:

• Real Estate
• Cryptocurrencies
• Gold & Precious Metals
• Tax Liens
• Private Money Loans

The main advantage of a SDIRA is the diversity of investments it allows. We’ll concern ourselves with private money or for this article. A Roth IRA, (a specific type of SDIRA), is often used in real estate and private money transactions. It matures when the holder is at least 59 and a half, as long as it has been open for at least five years. When the money is accessed, it is free from tax liabilities. 

These are the roles and responsibilities of a lender and borrower in an SDIRA loan transaction.

Private Money Lender

The private lender firstly needs to establish an SDIRA with an IRA custodian or trust company that allows alternative asset investments. Retirement assets that you plan to use for investments, can be rolled over from other accounts. Many investors choose to establish an LLC owned entirely by the SDIRA, though this is not a requirement for hard money lending. An LLC is likely to cut down on transactional fees.

Additionally, if the lender chooses to open an LLC, they should also have a bank account affiliated with that LLC. This is achieved by providing the lender with the LLC articles of formation, a Tax ID#, and an SDIRA operating agreement. If you have full checkbook control of your SDIRA, as the manager of the LLC, you can send funds directly to the borrower as part of the loan agreement.

The lender usually sets the terms of the loan. These customarily include the following:

1. Origination fees or upfront points
2. Interest rate
3. Loan term
4. The wording of the documents

Once the loan closes and the money is sent to the borrower, they make their payments, as specified in the loan agreement, directly to the SDIRA or LLC held within the SDIRA account. The account holder is not allowed to access these funds for personal use or have the borrower pay them directly to the SDIRA holder.

Private Money Borrower

If the SDIRA is set up for the sole purpose of funding one specific loan, and lender and borrower may choose to negotiate the terms. However, if the lender is in the business of lending from their SDIRA regularly, they may want to control the loan terms. 

A borrower can access their funds faster through a private lender (with checkbook control) than a traditional bank This could be important as a fast closing will help sway a real estate deal in the borrower’s favor. 

Pros of Private Money Lending

Private money lending, sometimes known as Hard Money lending, has become the go-to source of borrowing for many businesses, particularly real estate. It holds many advantages over traditional lending from banks, which we’ll explore here.

Speed

Speed is the main reason, most people choose to select a private money loan over traditional bank financing. Real estate investors rely on quick closings to buy and flip properties in a competitive market. The same is true of any business where access to fast money is crucial. Traditional banks are known for red tape and lengthy approval processes. Many private lenders can provide funding in days, if not hours.

Less Paperwork

Traditional lenders have to adhere to a bank’s extensive regulations, which results in vast amounts of paperwork and compliance materials. Private lenders are often willing to base a loan on the project itself rather than a borrowers’ financial history. In the case of real estate, the loan is often secured by the property being borrowed on, meaning the lender is in the first lien position, should things go bad. This is often enough to secure a loan with minimal paperwork.

Flexible Loan Terms

Private lenders can essentially create a customized loan product to fit each project they are lending on. This adds value for the borrower and means a lender can potentially turn their money quickly. Many private lenders may forgo a monthly payment and agree to a final payment at the end of the project. In the case of funding a fix and flip project, this means the borrower will pay off their private money lender directly from the proceeds of the sale of the rehabbed house. This allows the borrower to work faster without having to find cash for finance charges.

Simple Loan Terms

Because the lender is usually in charge of creating the loan they can create far simpler loan terms than traditional banks. The points and fees are straightforward, without numerous hidden costs padded into the deal, which is often the case with a traditional lender.

A Lucrative Investment Vehicle

An SDIRA is a lucrative investment vehicle that allows individuals to become their own bank. They can lend money at a higher rate than traditional banks, with greater flexibility and without the need to get a securities license or adhere to customary banking regulations.

Cons of Private Money Borrowing

The main downside of a private money loan over a traditional bank product is the higher interest rate a private loan is liable to carry. However, when time is of the essence, this is considered a price worth paying for most borrowers who prefer back-end loan payments. This allows for a faster job completion time. 

For a lender, a higher rate allows their money to make money for them passively, with minimal risk.

For any business transaction to be worthwhile, it has to be a win/win scenario for both sides. Lending money through an SDIRA allows the lender a tax-free way of maximizing their retirement account. Lenders in effect can become investment bankers without the need for any licenses or red tape associated with the banking industry. A good lawyer and a rock solid contract should safeguard their investment. For a borrower, it allows access to money quickly without the headaches and paperwork associated with a traditional lender.

Interested in learning more about note investing? Acquiring your first real estate note or adding to your note portfolio? Reach out to REID Lending Partners! 

Finding a worthwhile note can be a chore if you try to do it yourself. We bring the right lenders together with the right investors, helping them build a high-yield real estate note portfolio the easy way. 

At any given time, we have a “menu” of available real estate loans, customized to fit the needs of any investor. From short-term with balloon payments to long-term guaranteed rates, your quest for yield ends here.