Lending is one of the top investment strategies Self-directed IRA investors use today.
But, before you lend, or use your IRA like a bank and lend your hard-earned retirement dollars to someone else, here are 10 things that you should consider to help safeguard your IRA.
Lending consideration # 1: Don’t loan on something you wouldn’t be excited to own.
This sounds pretty basic for most people. But, here’s what this means. In the worst case scenario, if you lend money out of your IRA, and you hold a promissory note (secured by real estate), if the borrower doesn’t repay you and the loan goes into default, your IRA will now own that property.
Do you know what to do with that property? Most people know what to do with a three bedroom, two bath house.
But, if you offer a loan to a real estate investor buying commercial property, ask yourself the question: “Will you be excited to own commercial property if the borrower goes into default?”
Lending consideration # 2: Hire professionals to help you evaluate your deals.
This is very important if you’re new to lending money. When you structure your deals, invest in a promissory note, or decide to lend your IRA money to a borrower, you need to find professionals who can help you through the process.
One professional might be a lender’s attorney. Lender’s attorneys can help make sure that your IRA – as the lender – is protected, and the verbiage within the promissory note protects the IRA and not the borrower.
Lending consideration # 3: When you do structure terms of your note, collect monthly interest fees.
Doing this lets you know when the borrower’s getting in trouble.
Often, investors structure promissory notes where the principal balance – and all of the interest charged – isn’t due until the maturity of the note. And the maturity of the note – when it’s due – could be two years down the road.
If you know your borrower is in trouble prior to that maturity date, but you’re not holding them accountable to make any payments back to your IRA, it might be very difficult to call that loan a performing loan or a non-performing loan.
So, make sure that you have some sort of gauge within the terms of your note that allow you to do that.
And one of the easiest ways to do that is structure it so you have monthly payments that are required from borrower.
Lending consideration # 4: If the loan goes into default, do not delay in taking action.
What does take action mean?
In most States, “take action” simply means that if your borrower misses a payment, send a notice of default. You’re not foreclosing on the borrower, just for the fact that they missed the payment by a day, or a couple of days.
There’s typically a process one has to go through to lead up to foreclosure. The first step for most people is just to send the notice of default. But, you can’t finish what you haven’t started, especially when it comes to foreclosures.
When you have to start that process, it starts with sending the notice of default after your borrower misses a payment.
Lending consideration # 5: Be careful on how much your IRA fronts for rehab projects.
When loaning to a borrower or a real estate investor that might have a heavy rehab, be very careful with how much your IRA fronts for the project.
A borrower needs $70,000 to buy a property, and $30,000 to fix it up.
If you loan all $100,000 out of your IRA at the front, you’re really relying on that borrower to make sure that they do the $30,000 in rehab.
What happens if the borrower dies, gets in a car wreck, or something else bad happens to your borrower where they don’t finish the rehab?
You foreclose on that property, and now it’s owned in your IRA. Guess what still has to be done? The rehab!
And if you own that property, your IRA has to come out with more money to finish paying for that rehab.
So how do you safeguard yourself? Do incremental funding.
Give the borrower $5,000 or $10,000 for the first set of repairs. Have them prove to you that the repairs are done before you send more money for the second set of repairs.
So, we recommend that – in general – you do not advance too much in funds for the rehab before inspecting that the rehab is being done properly.
Check out our next blog post for the remaining 5 considerations you should make before lending in your Self-Directed IRA.
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