In most cases, individuals will approach a traditional financial institution such as a bank or brokerage firm about borrowing money for real estate. Sometimes, however, they are unable to procure the loan because of poor credit, lack of documentation or a number of other reasons that cause the lending institutions to view them as poor risks. This when they might consider approaching a private lender who is lending money with his or her IRA. The term, “IRA” can mean one’s Defined Benefit Plan, 401K, Roth IRA, IRA, SEP-IRA, or Money Purchase Plan. A lot of lenders are under the misconception that they can only lend money for stocks or bonds. However, this is untrue. Lending money with an IRA for real estate is a perfectly acceptable practice that is growing among knowledgeable investors who are willing to take a bit of a higher risk than a bank is.
In these cases, the terms are negotiable, but in most cases, the lender chooses to charge higher interest rates to make up for the risk that is involved. However, a way in which to considerably reduce the risk to the lender who is lending money with an IRA is to secure said loan with real estate. Once the loan is secured, the lender can actually make out very well even if the borrower defaults on the loan and the lender needs to foreclose on the real estate property.
In this case, rather than the lender receiving the interest payments that were anticipated, his or her IRA will take ownership of a property that can be worth much more money than the actual expected return.
If one is considering becoming a lender with an IRA who would like to invest in real estate, he or she should take into consideration all of the issues involved with foreclosing on a property, and this process should come prior to signing any papers. It is entirely acceptable, of course, to lend money without securing the loan, but in these cases, it is not wise because the lender must do this at his or her own risk.
A number of rules apply to lending money with one’s IRA for real estate investment purposes. For example, an IRA cannot lend money to a person who is considered disqualified, as in the IRA owner’s immediate family (except siblings) and any professional associations who might be taking care of the IRA or financial business of the lender. This would include employers and fiduciaries.
Each state has different rules regarding lending money with an IRA. These include how high an interest rate the lender is allowed to negotiate. It is highly advised the lender seek the services of an attorney who has experience in these types of transactions. There are extremely unfortunate penalties involved for people who do not follow the rules or who engage in restricted lending behaviors. They run the risk of having to pay taxes on the full amount of their IRA and other penalties that are simply not worth taking risks for.