Borrowing is tough these days. The banks – traditional hometown sources of credit for both homeowner-occupants and investors – just aren’t doing it like they used to. Which is tough on Americans who want to buy houses. But it opens up quite an opportunity for Real Estate IRA owners.
Many people are under the impression that your Real Estate IRA can’t lend money. But this is just not true. Your IRA just can’t lend money to you! Nor can it lend to your spouse, children, parents or direct ascendants or decedents, or to any entity they control. Outside of these restrictions, though, your IRA can lend money to just about anyone you like.
Real Estate IRA lending is not out of bounds in any way. Think of it: Any IRA that owns a bond or bond mutual fund is lending money, quite literally! That’s all a bond is – an IOU.
One of the most popular ways Americans are able to sidestep the extra expenses that investment companies add, while increasing diversification and possibly boosting potential risk-adjusted returns is private lending – especially real estate lending. Here’s why it makes sense.
- Real estate lending allows you to easily secure your investment with an underlying interest in the property. The property secures your loan. If there’s a problem with payment, you have the option to foreclose on the property and make yourself whole.
- Interest on real estate loans is generally tax-deductible to the borrower. This enables them to pay higher interest than they would otherwise on a personal loan.
- Real estate almost never drops to zero.
- Real estate lending on individual properties is not closely correlated with broad markets. Devoting a portion of a retirement portfolio to real estate lending can help you diversify your investments against sudden drops in the stock market or corporate bond market.
- Mortgage loans are usually structured to combine interest and repayment of principal. Most corporate bonds and government bonds generally just pay the coupon payment every six months. As such, mortgage lending may provide a better match for your cash flow needs and living expenses than other forms of lending.
- You can select your risk level and interest rate.
- You can lend on assets, rather than on income. Asset-based lending means you are not relying on the borrower’s future income to pay the loan. Your security is in the asset. Many people with iffy credit will pay higher interest to secure an asset-based loan as opposed to an income-based loan. But if your security in the property is sufficient, and you are conservative in your valuation estimates, asset-based lending is quite safe and possibly safer than income-based lending – yet usually pays more than owning a garden-variety GNMA bond! This is one of those elusive “free lunches” investors love!
Principles for Real Estate IRA Lending
Safety first. When lending money, your first priority is always providing for the safe eventual return of your capital.
Segregate Money. Maintain a strict separation between your personal capital and your IRA lending activities. Yes, it’s possible to form a syndicate with your own self-directed IRA and lend on the same project. But this could expose you to potential conflicts of interest. If only a partial recovery is possible, who gets paid first? You or the IRA? Use caution when getting involved in any deal with your IRA capital. The best practice is generally to keep things entirely separate. Don’t cross the streams!
Don’t fall in love with a deal. To be a lender, you must be willing to look at each deal with a gimlet eye, and make some very rational, dispassionate calculations about risk and reward. Never lend because you ‘like’ someone. And don’t lend to your nephew, even though under IRA prohibited transaction rules it’s not technically verboten. Lending to friends and relatives can cloud your judgment and muck up both the deal and the relationship.
American IRA is a leading national authority on self-directed IRA investing and is one of the top-ranked third-party administrators of self-directed IRAs in the nation. We frequently schedule webinars and events designed to educate investors on self-directed IRA lending and real estate lending. Visit us online at www.americanira.com, or call us at 866-7500-IRA(472).