New custodian requirements are causing headaches for some retirement investors and are causing them to look elsewhere. Investors that have their retirement accounts at some of the common publicly traded custodians are being told that they can no longer hold private investments under certain thresholds.
The biggest challenge is that these custodians are no longer holding private investment opportunities for under $1M. For investors with smaller accounts that choose to remain with these certain custodians, they will no longer have the option to put their money into private investments. Assets such as real estate, notes, and private entities could all be eliminated from the list of possible investment options.
How Can a Self-Directed IRA Help?
Self-directed IRAs could be the answer to the problem. With a self-directed IRA, you have the ability to diversify your investment portfolio by choosing from the broadest possible spectrum of investments, including those not traded on a stock exchange, and you’ll never have to worry about investment minimums or maximums. Self-direction means you get to make all the decisions about your financial future, and your custodian will provide account administration. Remember! Not all custodians are created equal!
You can build wealth faster with the freedom to purchase almost any type of investment. Common investment choices include all types of real estate, newly created and existing promissory notes, LLCs, limited partnerships, private stock, trusts, oil and gas, tax liens, and much more. All types of IRAs, including Traditional, Roth, SEP, and SIMPLE IRAs, as well as Coverdell Education Savings Accounts (CESAs) and Health Savings Accounts (HSAs), can be self-directed.
Why Self-Directed at Quest?
Quest Trust Company is the nation’s premier self-directed IRA custodian, administering clients all across the U.S. Not only do we provide world famous account administration and customer service, we put a big focus on education and making sure our clients are equipped with all the knowledge and resources they may need. In our Education Center, you can experience live webinars, blogs, recorded videos, and more. In addition, we’re always adding the the latest online features, allowing you to fund investments online within 24-48 hours – one of the fastest funding times in the industry!
Benefits of Self-Directing Your IRA at Quest:
Ability to view and manage accounts & investments online in the Client Portal
Submit investments and yearly Fair Market Valuations 100% online
Pay expenses with our team or online with the Expense Pay Feature
24-48 hour processing times for almost all request involving accounts
Access to 35 Certified IRA Services Professionals and endless continued education
Here’s How We Can Help
For those that have a larger IRA and still want to participate in private assets, Quest can help. If you are looking for a qualified and knowledge custodian to place your private assets or start new private entity investments, call an IRA Specialists to see how we can make your move to Quest.
Thank you for joining me today. I have Quest’s Dallas Office Supervisor and transaction specialist Robyn Ruston here with me today. She’s an expert when it comes to almost anything involving real estate, notes, or private entity purchases. Today, we are going to be talking about how to streamline the process for lending and borrowing when a Self-Directed IRA is involved.
Sarah: If someone is interested in doing a private loan with their Self-Directed IRA, what does one even need? Whether that be making sure preliminary boxes are checked or providing forms, what is needed to make sure that funding gets taken care of?
Robyn: Well, first and foremost, the IRA accounts have to have funds. Then, it depends on what type of note they want to do. So, they decide that with the borrower, what kind of note they want to do, (secured or unsecured). For instance, we’re always going to have to have a Direction of Investment Form. It doesn’t matter what kind of loan they’re going to do, they will always need the Direction of Investment. It’s our internal form that tells us, you know, where to send the money, their interest rate, maturity date. It just gives us the general information of what the investment is. It tells us the pertinent information on how to process the funds.
Sarah: And that information is very important. We can’t fund without it.
Robyn: Right. So, if they want to do one that is secured with a note, then we would need a promissory note and we need the deed of trust and/or mortgage showing that the IRA is the lender. Once the note is completely paid off, the borrower will submit a release of lien and Quest will sign it releasing the IRA from that asset. The supporting documents specify the terms between the borrower and the lender. The biggest thing to remember is that, in order for them to do any type of investment, we always need supporting documents determining whatever they’re going to do.
Sarah: Got it. I also heard you mention… you touched on the fact that they have to decide all those terms. That’s an important part there.
Robyn: Yes, that’s decided between the borrower and the lender. They decide all the terms, and how it’s going to be written. They find somebody who drafts all the documents surrounding the investment. That’s what makes it self-directed. As the custodian, we review all documents and we make sure that it’s in compliance with IRA terms. We make sure that we have the right vesting on there, and that we have the information that’s needed in order for us to be able to hold that investment.
Sarah: Perfect. So, I’m sure that you probably have lenders calling in all the time asking “how do I fill out these forms?”, and “What do I do?”. How often do you get lenders and borrowers calling in for questions and how do you address those?
Robyn: When it comes to answering questions, we can answer questions for the borrower and to the lenders. But we can only answer questions for the borrower to an extent, as long as they don’t pertain to the lenders account. We don’t mind like talking to the borrower to let them know what’s needed or the steps for the investment process, just so both sides of the party are fully aware of the steps that are required to make an investment happen. So, we do also talk to the borrowers often.
Sarah: I’m sure one of the biggest questions that a lot of the borrowers have when they call in is “I have to pay back my lender! How do I do that?”. How does the lender get paid back? Can you talk a little bit about that and where those funds have to go?
Robyn: There are a couple of different ways. We can always provide Delivery Instructions to our lenders, so that the borrowers can make payments a couple different ways. They can wire over the funds to an IRA account. They can send them via ACH or through check, and they can even use our online payment methods. You know, we make it pretty simple and easy. They will send the funds directly to Quest and then we will allocate those properly to the clients’ IRA accounts.
Sarah: Now, one thing that you touched on there that’s really important – something that I think all of our readers should know – is those funds have to go back to the IRA accounts. I’m sure that’s a big mistake many people make. Interest payments must be made to the IRA.
Robyn: Exactly
Sarah: So, while they’re going through that funding process, what’s one of the biggest things that you see holds people up getting that investment funded on time?
Robyn: Most of the time, you know, what I see is that the documents aren’t worded right; we don’t have the correct language, meaning the vesting is incorrect. Another is that we don’t have any wiring instructions. So, the best way to just kind of make that go quicker is to make sure the client understands a few things. We always let the client know, “why don’t you go ahead and get the terms drafted and then submit those over to us.” Let us look at them. We’ll tell them, “this needs to be corrected. That needs to be corrected.” Once you get the final draft, that’s when I would get people’s signatures and stuff like that, because every time you make a mistake or every time you have to correct the document, you have to go back and get a signature again.
Sarah: I can see how that could be a holdup.
Robyn: The best way to streamline the process is to go ahead and just submit all documents over for a preliminary reviewWe can’t draft it, but we can review it and let you know if it meets all of our requirements. We can say, “go ahead and get the borrower to execute” or we can let them know, “hey, your vesting is incorrect or you’re missing the maturity date, basic information”. That way they can correct it.
Sarah: And even if one thing is missing, that’ll hold something up. We have got to have it all.
Robyn: We’ve got to have it all.
Sarah: One thing that you mentioned at the very beginning when we were talking about what’s needed, you said that it depends on what type of note and I want to go back to that, because that was really important. There are unsecured versus secured. Now, if somebody wants to do an unsecured note, what type of due diligence should be done before entering in to a Self-Directed IRA investment like that.
Robyn: Yes, we recommend that the client does a bit of research and that they know what they are investing in, especially with an unsecured note. The great thing about our IRAs is that they are self-directed, but it can also put more responsibility on the account holder since all of the investment details are curated between the lender and the borrower. It’s best definitely to do some due diligence and just make sure that they are aware of what they’re investing in, making sure that they are agreeing to these terms in this loan, right? And then to just making sure that everyone’s goals is met at the end of their investment, their promissory note.
Sarah: Mhm. Perfect. Moving right along… What are some common questions that you get? What do people call in and have the most questions about? Let’s address some of those.
Robyn: [chuckles] Mostly, “where’s my funding?” Oftentimes, we get asked, “can we go ahead and fund without a signature from the borrower” or “how is the investment status, what is the status of the investment?”
Sarah: And if they wanted to check on the status of an investment, do they have somewhere where they can do that?
Robyn: Yes. The QTC Investment Hub has an investment tracker. It’s located in their Client Portal.
Sarah: Awesome, well do you have any other words of advice that you would give to either lenders or borrowers to help them streamline the process?
Robyn: Yes. To just make sure that, as the client, they are responsible for knowing what is exactly needed for their note and what we look for. That way they know for when they’re getting their note drafted. We can always send it over to them through email. So, when they’re getting it drafted they can make sure that everything is included. I also recommend that, before they even start to process, do their digital research. Really look into who they’re borrowing from or on the other side, who they’re lending to. Go on the internet, Google at home, see if you can find out any information, and check with somebody who’s already invested with those people. You know, just kind of get their feedback on anything. Borrowers should be willing to let you talk to somebody who has already invested with them or lent them money.
Sarah: That is such a good point.
Robyn: If they have a good track record, they shouldn’t have any problem answering your questions. So, just pick it apart and just make sure that you know what you’re going into. And that last thing is just to set realistic expectations and times. All of this will really help in streamlining the process.
Private loans and other notes continue to be one of the most popular investments held in Self-Directed IRAs, and it’s’ helpful to understand some of the ways to keep the process moving smoothly. If you have more questions about how to lend and borrow funds with a Self-Directed IRA, feel free to call our office at 281.492.3434 and a representative will be happy to help answer any questions. To learn more about how to get started investing with a self-directed IRA, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE.
Whether you’re a first time home buyer, an experienced fix and flipper, or an expert in rentals, one aspect will be present for almost everyone: funding. Investors will always need money for deals and sometimes the traditional bank loans aren’t possible for everyone. Others just prefer the flexibility of being able to work out a deal on their own terms.
There’s plenty of options available, but private lending by using self-directed IRAs has proven time and time again to be an option many investors seek out when it comes to their real estate or other alternative investments.
According to a recent study from the Investment Company Institute, $28 trillion dollars were in retirement assets, and of that, $9.2 trillion dollars was reported to be in IRAs alone. With that much money available for use in IRAs, it’s nearly impossible not to be curious about how to use those funds for private funding.
For lenders and borrowers alike, private loans with self-directed IRAs have provided opportunities for successful deals and have given investors the ability to have options. Whether you’re looking to borrow private funding or loan out your own, here is everything you need to consider when getting involved in a private loan!
Why Private Lending?
As mentioned, sometimes a normal loan from a bank or hard money lender just doesn’t work for unique situations. Especially in a market like real estate where investors are seeking to get creative with their strategies, having an option like private financing is almost necessary.
With a Self-Directed IRA, investors can choose to loan out their retirement funds on their terms, as decided and agreed upon with the person borrowing those funds. These agreements are usually more customizable than regulated bank loans, and typically the interest works out in favor for the investor, making it a great investment for a self-directed IRA.
Private loans also give the investors the ability to collaborate when doing the loan. Maybe one investor doesn’t have the ability to loan out the full amount of funds a borrower is needing, but the flexibility of a private agreement makes it possible for two or multiple people to come together to supply the total amount to loan out. This flexibility also comes into play with timing, too.
Private loans are ideal when needing to purchase property in a short period of time, whereas it sometimes can take a while when applying for a traditional loan.
Considerations When Private Lending
Just as banks have a certain set of criteria when vetting someone for a loan, private lenders typically do, as well, although the requirements are usually different and much fewer. Things that a private lender may consider when deciding to lend are the borrower’s credit scores, the investment loan to value ratios, the amount of time the investment may last, and if in the event the money was not paid back, is that investment something the investor would want to own. These are just a few considerations a lender may have.
As a borrower, it is wise to have a success book (if applicable) and be able to properly present your investment. Usually, when seeking a private loan versus a traditional loan, there is a higher approval rate for borrowers.
Borrowing from a bank can be time consuming and stressful, but private lending doesn’t have to be. Whether you’re a borrower looking for capital, or an investor with money looking for a good deal, private loans with a Self-Directed IRA have proven to be great investments that are flexible enough to work for everyone.
To learn more about how Self-Directed IRAs can be a source of private financing, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE.
Personally, I think Shakespeare had it wrong when he penned this advice in Hamlet: “Neither a borrower nor a lender be; For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry.” Perhaps he may be forgiven for his error, however, since Shakespeare suffered from a lack of the tremendous benefits of a truly self-directed IRA.
Money in self-directed IRAs can be loaned out to any person who is not a “disqualified person.” While this means that you cannot loan yourself or other related disqualified persons money from your self-directed IRA, you can loan the money to anyone else. Loans can be secured by real estate, mobile homes, equipment or anything you like. If you are really a trusting soul, you can even make a loan from your IRA unsecured (although in that case I personally would tend to support Shakespeare’s advice).
First, let’s look at it from the borrower’s perspective. At our office we offer a seminar entitled “Make Money Now With Self-Directed IRAs.” One of the ways you can make money for yourself right now with your knowledge of self-directed IRAs is by creating your own “private bank.” To do this, simply share the news that an IRA can be a private lender, refer people with IRA money to Quest to open a self-directed IRA, and then borrow their IRA money for your own financing needs.
With private financing the loan terms can be whatever the borrower and the lender agree to within the legal limits. If you know a person who is getting 5% in a “safe” IRA at a bank, and you can offer them 9% secured by a first lien on real estate with only a 70% loan to value, would they be happy with that? Even with a higher interest rate, private financing can work for you. IRA loans can be done quickly and without a lot of fees or fuss, which may mean you can get a deal which might be lost if you had to wait on the bank. This is especially true in distressed sale situations, such as a pre-foreclosure purchase.
From a lending perspective, your IRA can grow at a nice rate while someone else does all the work. In a typical hard money loan, the borrower even pays all of Quest’s modest fees as well as any legal fees for preparation of the loan documents. True, you won’t hit a home run with lending, unless you are fortunate enough to foreclose on the collateral. But the returns can be quite solid. For example, by making very conservative hard money loans my Mom’s IRA has grown by about 10.5% in one year. This is much better than the amount she was earning in her money market fund before she moved her IRA to an Quest self-directed IRA.
Even small IRAs can combine with other self-directed accounts to make a hard money loan. My brother recently combined his Roth IRA, his traditional IRA, his wife’s Roth IRA, his son’s Roth IRA, his Health Savings Account (HSA), and 5 other IRAs to make a hard money loan. The smallest IRA participating in this loan was for $1,827.00! Each IRA made 2% up front and 12% interest on an 18 month loan, secured by a first lien on real estate with no more than 70% loan to value.
One thing to avoid in hard money lending is usury. Usury is defined as contracting for or receiving interest above the legal limit. The usury limit varies from state to state, with a few lucky states having no usury limit at all on commercial loans. Some people have the theory of “What’s a little usury among friends?” However, if the investment goes bad and your IRA has made a usurious loan, the consequences of the borrower making a claim of usury could include the loss of all the principal of the loan plus damages equal to 3 times the interest. Some states even have criminal usury statutes. It is best to consult with a competent attorney prior to making a hard money loan to make sure your IRA does not violate any usury laws.
To see how well hard money lending can work, let me give you an actual example. One of our clients made a hard money loan from his IRA to an investor who purchased a property needing rehab. The terms of the loan were 15% interest with no points or other fees except for the attorney who drew up the loan documents. The loan included not only the purchase price but also the estimated rehab costs. The minimum interest due on the loan was 3 months, or 3.75%. The investor began the rehab by having the slab repaired, and before he could take the next step in the rehab process, a person offered him a fair price for the property as is. The investor accepted the offer, and they closed about 6 weeks after the loan was initiated.
From the investor’s perspective, was this a good deal? Yes, it certainly was! True, he was paying a relatively high interest rate for the time he borrowed the money. However, he was able to purchase a property with substantial equity which a bank most likely would not have loaned him money to buy due to the condition of the property. Also, while the interest rate was high, the cost of financing was actually comparatively low. With a normal bank or mortgage company there are fees and expenses incurred in obtaining the loan. Common fees include origination fees, discount points, processing fees, underwriting fees, appraisal fees and various other expenses relating to the loan. On the surface an interest rate may be 8%, but the cost of the financing is actually higher than 8% since a borrower has to pay the lender’s fees in addition to the interest on the loan. Spread out over a lengthy loan term these additional fees do not add much to the cost of the financing. However, if an investor has to pay all of these fees up front and then pays the loan off in only 6 weeks, the cost of the financing goes way up.
In this case the investor’s total loan costs were limited to 3 months minimum interest at 3.75% plus $300 in attorney’s fees for preparing the loan documents. Best of all, the investor walked away from closing with $20,000 profit and no money out of his pocket! Far from “dulling the edge of husbandry” this loan actually made the “husbandry” (ie. the purchase and resale of the property) possible. Incidentally, the purchaser of the property was absolutely thrilled to get the property at less than full market value so that they could fix it up the way that they wanted it.
What about the lender in this case? The lender was also quite happy with this loan. His IRA received 3 months of interest at 15% while only having his money loaned out for 6 weeks. For the 6 week period of the investment, his IRA grew at a rate of approximately 30% per annum! Although his yield was above the legal limit for interest inTexason loans secured by real estate, prepayment penalties are generally not included in the calculation of usury here, so there was no problem. The investor was happy, the new homeowner was happy, and the lender was happy. Anytime you can create an investment opportunity with a win-win-win scenario, you should.
When I lecture about hard money lending, I ask the audience what they think is the worst thing that happens if you are a hard money lender. Invariably, most people in the audience answer that you have to foreclose on the property. Nonsense! If you are doing hard money lending correctly, the worst thing that can happen is that the borrower pays you back! Unfortunately, this is a common risk of hard money lending. Most hard money loans are made at 70% or less of the fair market value of the property. If you are fortunate enough to foreclose on a hard money loan, your IRA will have acquired a property with substantial equity while the investor did all the work of finding and rehabbing the property!
While it is true that foreclosing on a property owned by a friend may cause an end to that friendship, a properly secured hard money loan will at least not “lose itself” as Shakespeare asserts. In fact, it may lead to substantial profit for your IRA! To avoid losing a friend, simply don’t loan money from your IRA to someone you would feel bad foreclosing on. In order to be a successful hard money lender, you do have to be prepared to foreclose on the property if necessary.
In modern times, especially with the invention of Cryptocurrency IRA, I believe the proper advice, at least in the right circumstances, is “Either a lender or a borrower be!” You can make more money for yourself right now by borrowing OPI (Other People’s IRAs). Borrowing from someone else’s IRA can even lower the total cost of your financing compared to a conventional loan from a bank or mortgage company, especially on short term financing. From a lending perspective, your IRA can make great returns by being a hard money lender, either through higher than average interest rates or, better yet, through foreclosing on property with equity. You may find that hard money lending from your self-directed IRA is a great way to boost your retirement savings without a lot of time and energy invested on your part.
Estimated reading time: 6minutesInvesting in real estate notes with your IRA is one of the most popular self-directed IRA investments available. But with this popularity comes common mistakes when people lend their IRA (and non-IRA) money out, secured by liens on real estate. Follow these 10 tips to avoid potentially costly mistakes when choosing real estate as an IRA self-directed investment.
1) You may end up owning this piece of real estate if your borrower defaults. Never loan on something you wouldn’t want your IRA to own. The risk of loaning your IRA investments toward real estate notes is matched by the reward: I routinely see yields from these loans at 12% and higher; however, borrowers can default and you may be left with the property in foreclosure. If you would be upset by the potential of taking over this property in foreclosure, you probably should not make the loan.
2) Do not advance IRA money for home repairs until the repairs are finished; then have the repairs inspected before advancing the money. This is one of the biggest mistakes that I see clients make with their IRAs. They fund the full loan amount expecting that the repairs will be done on the property, but the borrower will actually need a little more money on another. If the loan goes bad, the IRA could end up with a property that hasn’t had the necessary repairs.
3) Do not loan money to someone you would feel uncomfortable foreclosing on. William Shakespeare wrote in Hamlet, “Neither a borrower nor a lender be/ For loan oft loses both itself and friend/ And borrowing dulls the edge of husbandry.” For the most part, I cannot agree with this advice, because lending and borrowing money drives our economy and increases economic activity. However, the part about a loan losing a friend is absolutely correct, in my opinion. If foreclosing on your borrower would cause you heartache, it is better not to make the loan. I have seen friendships destroyed over a loan gone bad.
4) If the loan goes into default, take action immediately. No one wants to admit that he or she has made a mistake in self-directed investing, but delaying action can be costly. You can always stop the foreclosure process once it has begun, but you cannot complete the process unless you start it.
5) Collect interest monthly so you will know if the borrower is getting into trouble. Many borrowers, especially investors, would prefer to pay interest at the end of the loan. But this exposes the lender to additional risk. The purpose of collecting payments monthly is both to:
Make sure the borrower remembers that he or she has to do something with that property in order to avoid the pain of the payment
Let you know if the borrower is in trouble because he or she starts missing payments
Keep in mind that unless you have contracted for monthly payments, you may not be able to foreclose, even if you do discover that the borrower is in financial trouble, because the loan may not be in default. This has actually happened to some of my clients.
6) If you are unsure about how to evaluate the loan, hire a professional to help you. Although a hallmark of the self-directed IRA is that it is “self-directed” — meaning that you make your own decisions and find your own investments — most IRA owners either do not possess sufficient knowledge or, in my case, sufficient time, to properly evaluate a loan transaction. My solution is to hire a professional to help me with the deals. He checks out the borrower, coordinates with the title company, orders the appraisal and usually a survey, makes sure insurance is in place and generally evaluates the loan. Naturally, he charges a fee for this service, which is passed through to the borrower on top of any interest and fees that my retirement plan may charge. This increases the cost of the loan; but in this case, the non-Biblical version of the golden rule applies, which is “He who has the gold makes the rules.”
7) Get title insurance for the loan. The purpose of title insurance is to shift risk away from you and to the title company. In Texas, where my office is, the incremental cost of title insurance is very small when issued in conjunction with an owner’s title policy. Regardless of the cost, making sure that your IRA is protected from title flaws is important.
8) Verify that hazard and, if necessary, flood insurance is in place, naming your IRA as an additional insured. It is very easy to miss this issue when you are trying to get everything completed right before a closing. Borrowers may get insurance at the last moment and simply forget to add your IRA as an insured. But if something goes wrong, you will want to make sure your IRA is named on the check.
9) Insist that the borrower provides you with evidence of payment when property taxes and homeowners association fees become due. The same thing would apply to hazard and flood insurance premiums, although normally you would receive notice of cancellation for non-payment of those bills. Depending on where you live, property tax bills can increase quickly due to penalties and court costs, which reduces your equity position in the property.
10) Get a personal guarantee if lending to an entity or to an individual with some weakness. When things are going well, you might be tempted not to insist on a personal guarantee, and indeed many borrowers will resist this. However, as we all have discovered recently, circumstances do change, and a personal guarantee may be helpful in collecting the debt. I collected on a note once where the property had decreased substantially in value due to vandalism and market conditions. Instead of foreclosing, I had my lawyer send a letter explaining to the guarantor, who had a significant amount of assets, that he was personally liable on the debt and that if he were unable to satisfy the note, I would pursue legal action against him and the borrower. A week later, a cashier’s check showed up that satisfied the lien.
There’s more to know when considering real estate for your self-directed IRA
This list of suggestions is not meant to be exhaustive. Other issues you will need to understand include:
Your lien position (personally, I only invest in first-lien loans)
Any state usury laws that might apply to the loan
At least a general idea of what the foreclosure process is in your state, in case the loan goes into default
Always get good legal counsel to assist you with loan documentation. Because the borrower traditionally pays for all expenses including legal fees, there is no reason not to have an attorney draw up loan documents.
Lending can be an excellent investment in an IRA. It is relatively easy to do and, if done correctly, has a comparatively low risk. Getting to know successful real estate entrepreneurs who borrow your IRA money may also lead to other, intangible benefits as well. Finally, be sure to learn the pointers for buying real estate with your self-directed IRA before you take any actions.
H. Quincy Long is a certified IRA services professional (CISP) and an attorney and is the president of Quest Trust Company, Inc., with offices in Houston and Dallas, Texas, as well as, Mason, Michigan. Email him at Quincy@QuestTrust.com.
Nothing in this article is intended as tax, legal or investment advice.
