Using Your Self-Directed IRA to Make Mortgage Loans

The tightening of the consumer credit markets that we’ve seen over the past few years has made it particularly difficult for many individuals to borrow money for their homes. And what’s true for individuals looking to buy their first home is even more acute for individuals who may be looking to save the homes that they original purchased with a relatively short-term (perhaps “interest only”) mortgages. Many of these borrowers planned to refinance their loans after a few years, but now find themselves unable to secure new mortgages.

While many individuals who know something about self-directed IRAs are aware that you can use the account to invest directly in real estate, it’s less widely known that you can also make mortgage loans as a way to put your account assets to work.

Properly Document the Loan. Making a mortgage loan with your self-directed IRA funds is different from other types of investing because what you get in exchange for your money is simply a promise that the borrower will repay that money plus interest. It’s true that the loan will be secured by a piece of real estate, but it’s absolutely essential that the loan documentation protect you and the property.

Choose Appropriate Terms. How long do you want to have your retirement funds committed towards the loan? Many self-directed IRA investors are not interested in having their assets tied up in a 15 or 30 year loan that may only pay a modest rate of return. Instead, one common technique for making mortgage loans from a self-directed IRA is to focus on providing short-term “bridge” loans to give a homeowner time enough to find a more traditional, long term, source of funding. For example, you might make a one or two-year mortgage loan, for which you can charge a significantly higher rate of interest than you could for a long-term loan. In order to guard against fluctuations in the value of the underlying property, as well as whatever borrower risks may apply, you may wish to limit the loan value to 50%, or perhaps up to 60% or 70%, of the property’s market value.

Screen Applicants. Your potential borrowers are likely to be individuals who have been turned down for traditional sources of funding. You’ll want to make sure to screen any borrowers to make sure you’re minimizing the risks of default.

Pay More Attention to the Underlying Property. If you decide to only make short-term mortgage loans from your self-directed IRA, you should pay more attention to the property that the borrower is using as security for the loan. Even if the underlying value of the property is adequate security for the loan, do you have a plan for what you would do if the borrower defaults and you have to take possession of the property? Do you have the resources in your self-directed IRA to go through the foreclosure process? Is it a property that you could quickly resell? Could you rent it out to a tenant and generate a positive cash flow?