Private Lending With Your Self-Directed IRA Explained

Promissory notes, Loan types, and how to get started.


What is Private Lending?

Private lending is a practice where individuals, investors, companies, businesses, and even self-directed IRAs, lend money directly to others, cutting out traditional banks. Private lenders usually have higher interest rates and set their own loan requirements, terms, and criteria for loans. These loans are usually documented through a promissory note and can range from personal loans between individuals to more structured loan arrangements secured by collateral.

Benefits of Private Lending

Private lending with a Self-Directed IRA (SDIRA) lets you transform your retirement account into a lending machine. It's a win-win-win situation:

  • You: Boost your retirement nest egg! By lending to businesses or individuals, you can potentially earn higher returns and diversify your IRA holdings beyond traditional investments.
  • Borrowers: Access to funding that might be trickier to get from traditional banks becomes a possibility. Faster approvals and potentially more flexible terms can be a game-changer for borrowers.
  • The Economy: Increased cash flow for businesses and personal projects can stimulate economic activity as a whole.

How Borrowers Benefit From Private Financing

Easier Approval Process

The approval process for private loans is often less stringent than that of traditional banks. Private lenders typically focus on the value of the collateral or the potential of the investment rather than solely on credit scores and credit history. This can be a significant advantage for borrowers who may not meet the strict requirements of conventional lenders.

When time is of the essence, private lending can be a lifesaver. Since there are fewer hoops to jump through, the turnaround time from the initial application to receiving funds can be much quicker. For those in need of immediate financing, private lending provides an expedient solution.

This type of private financing is particularly popular with real estate investors and REALTORS needing additional financing. When investing in real estate, timing is of the essence. These types of loans can help secure a real estate property deal due to the fast turnaround times.

More Negotiable Terms

Private loans often come with the benefit of negotiable terms. Borrowers can work directly with lenders to agree on interest rates, repayment of loan, and other loan conditions. This flexibility ensures that the loan agreement can be tailored to the specific needs and circumstances of the borrower.

Access to Larger Amounts

For some borrowers, private lending can offer access to larger sums of money than they might obtain through traditional banks. This is especially true for short-term loans backed by substantial collateral.

How SDIRA Investors Benefit From Private Lending

Higher Returns

Private lenders can benefit from higher interest rates compared to traditional savings accounts or other investments. By carefully selecting their borrowers and negotiating favorable terms, lenders can achieve a lucrative return on their capital. As the private equity lender you set the annual percentage rate (APR).

Asset Diversification

Investing in private loans can diversify a lender's retirement portfolio beyond stocks, bonds, and real estate. By including private lending in their investment strategy, IRA owners can spread risk and potentially improve the stability of their returns over time.

In order for you to diversify your retirement account beyond the stock market, you need a self-directed retirement account. Whether you have a Traditional IRA, Roth IRA, or old 401(k), these accounts can be a lender to diversify your investment holdings.

Control Over Investments

IRA lenders in private lending scenarios have a greater degree of control over their investments. They can choose whom to lend to, define the loan terms, and decide on the security required. This hands-on approach allows lenders to manage their risk and tailor their investment strategy to their comfort level.

Loan Types

Personal Loans

Personal loans through private lending can be informal, such as a loan between non-disqualified individuals. However, it's still recommended to have a written agreement in place to avoid misunderstandings and protect both parties' interests.

Private lending with a self-directed IRA is documented through promissory notes. These notes can be secured or unsecured.

Secured Promissory Note 

A secure promissory note is like a fancy IOU with extra muscle. It's a legal agreement between a lender and borrower outlining the loan details (amount, interest, repayment terms). But unlike a regular IOU, a secure promissory note involves collateral, like a house or car. This acts as a guarantee for the lender. If the borrower defaults (doesn't repay), the lender can legally seize and sell the collateral to recover their losses. Secure promissory notes offer lenders more security.

Unsecured Promissory Notes

Unsecured promissory notes don't require any collateral. Unsecure notes might bring you a higher return, but they do come with more risk if the borrower defaults.

Real Estate Investments (Mortgage Loans)

Secured Real Estate Notes

Private lending is particularly common in real estate investments. IRA investors may lend money to commercial real estate projects, property developers, or individuals looking to purchase or renovate properties.

These loans are usually secured notes backed by the property itself, providing the IRA lender with added security.

Mortgage notes offer a unique way to benefit from real estate investments without the day-to-day management responsibilities.

It's a win-win! You get potentially higher returns than traditional investments and avoid the headaches of property management. Several companies specialize in selling, buying, and even managing the cash flow for these investments.


Small Business Loans and Business Financing

Entrepreneurs often turn to private business lenders when they need working capital for their businesses but can't secure traditional financing. Loans from private lenders can offer the necessary funds to start or grow a business, often with more flexible terms than a bank or traditional lender.

These private business loans are a way to diversify your retirement portfolio with assets that are not on the stock market. Imagine investing in the next startup with the potential to become a future giant.

Peer-to-Peer Lending and Pooled Funds

Lending groups for personal loans or business loans, connect borrowers with lenders directly. Instead of a bank, members pool their money to offer loans to those seeking to borrow money. These loans are typically arranged online through platforms that set clear rules for borrowing and investing.

How to Become a Private Lender

Turning your IRA into a private lending machine takes some planning! First, not all IRA custodians allow these investments, so finding the right one is key. Next, brush up on IRS rules for IRA lending. Remember, you want to keep your investment tax-advantaged. Here's how private lending with a self-directed IRA works in simple steps:

  1. Open and Fund SDIRA Account: In order for your IRA to be a lender, you must have a self-directed account. You can open an account online and move funds, penalty free from another institution.
  2. Find a borrower: Look for businesses or individuals who need a loan and qualify under IRA lending rules (no prohibited transactions).
  3. Negotiate the loan: Agree on terms like amount, interest rate, and repayment schedule with the borrower. You'll also decide if you want collateral (like a house) to secure the loan.
  4. Draft a contract (promissory note): This legal document outlines everything agreed upon - loan amount, interest rate, repayment terms, and any collateral. There are many online resources, but we recommend you get a lawyer to make sure it's airtight.
  5. Use your IRA to fund the loan: Your IRA custodian will handle this part once you submit your request via a Buy Direction Letter.
  6. Collect repayments: The borrower makes payments according to the agreement, and they go directly into your IRA.

While private lending offers several benefits, it's not without risks. SDIRA lenders should perform due diligence to ensure that the borrower is trustworthy and the investment is sound. 

Private Lending With Self-Directed IRAs

Private lending presents a compelling alternative to traditional financing for those seeking flexibility, and speed. For SDIRA account holders, it helps you diversify your retirement portfolio and the potential for higher returns.

Take advantage of this strategy. Download the free eBook. 

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Private Lending Frequently Asked Questions

What is a private lender? 

A private lender is a non-bank institution that loans money to individuals or businesses. These lenders can be investors, individuals, companies, and even self-directed IRAs.