With thousands of accounts nationwide, our firm has many investors from coast-to-coast who have been quite successful at private lending within a Self-Directed IRA. This kind of lending has the advantage of competitive yields, terrific flexibility on terms and pricing (if you avoid the big P2P lending sites, which generally shoehorn borrowers and lenders into a generic payment schedule), and low correlation with other asset classes.
Historically, this kind of lending has been quite profitable. But as with any kind of investment, it has its risks, which are up to you as the Self-Directed IRA lender to manage. Here are some of the tips we’ve compiled from investors who have found terrific success in the private lending arena.
- Use the home court advantage. If you stick to localities and industries you know well, you can do a much better job of assessing the real risks of a potential loan. For example, if you know your area, you can tell if the Italian restaurant looking for financing has 20 competing Italian restaurants within a five-mile radius. You know if it has adequate parking or a nearby draw. You will know if seven restaurants have tried to make it in that location and failed. When it comes to unsecured loans, the borrower’s sparkling credit score won’t help you in that situation. It’s tough to get that kind of on-the-street knowledge when you’re going through a major website. That convenience comes with a very high cost, indeed. Stick to areas you know.
- Don’t ‘wing it’ on collateral. That collateral is important – and the borrower knows more about it than you do. Where appropriate, get an informed and arm’s length second opinion. For example, use a licensed appraiser or other expert whom you select. Don’t let the borrower choose the appraiser. If the collateral was overvalued during underwriting, it increases the chance of the borrower just walking away – leaving you with collateral you don’t really want, and a loss.
- Assume a recession will hit six months into the loan. Will the borrower or the borrower’s business survive? Will it have the available revenue to cover loan costs? Does it have diverse cash flows? Does it have reserves? How long can it go with severely depressed revenue before the owners have trouble making loan payments?
- Don’t be afraid to get a personal guarantee. The bottom line is safety of principal. If there aren’t enough assets in the corporation to do that, you need to protect yourself before anything else. It’s commonplace in small business lending.
- Establish a set of criteria that you’re comfortable with. One you know the risk profile for and that you know how to underwrite.
- Be picky. It’s not unusual for commercial small business lenders to decline well over half of all inquiries – and often that figure is closer to 70 or 80 percent.
- Remember, in Self-Directed IRAs, you can’t write off bad debt losses. You get what you get.
- Unlike stocks, there’s not much upside to making concentrated bets, unless you have an equity sweetener, like you do with convertible bonds.
American IRA specializes in serving investors who use Self-Directed IRAs to shelter their lending and investing portfolios from taxes. For more information on private lending within your Self-Directed IRA, or to get started, visit www.americanira.com, or call us today at 866-7500-IRA(472).
We look forward to working with you.