By John “Jack” F. Kiley, CPA, CISP
Partner / MidAtlantic IRA, LLC
Private money lending through a Self-Directed IRA or 401(k) to real estate investors is a commonly used strategy that may grow retirement funds. In addition to consulting a team of advisers to decide if the debtor’s investment plans are in unison with your professional portfolio, there are a few case-specific characteristics to consider. Here are five components of a private loan to evaluate
1. PROFESSIONALLY CONSTRUCTED PAPERWORK
The first thing a private lender should look at is the professionalism of the paperwork involved with the potential investment. Did the debtor seek professional help from a lawyer or financial consultant while drafting the contract, deed, promissory note, etc.? If so, it’s imperative that you speak with the professional who the debtor claims helped draft the documents to ensure the paperwork is legitimate.
2. REPAYMENT STRATEGY
When lending money, you and the debtor must agree on a plan of repayment that includes how often and in what amount, in addition to the interest rate, payments will be made to your IRA in order to pay off the note. The two of you should also discuss the possibility of late payments and the importance of signing all checks to and from your Self-Directed IRA.
Always ask for title insurance on the property and verify with the insurance company that your IRA is insured in the event of property of liability loss. You should also look into initiating “key man” insurance on the borrower to further lessen your accountability.
4. EXIT STRATEGY
Both you as the lender and the debtor will have an exit strategy. For you, that means understanding the costs, time and paperwork necessary if you must foreclose on the property because the debtor may stop paying off the loan. Also know the debtor’s plans if he or she decides to back out of the deal. Will he or she sell it or refinance it? Will he or she look for another piece of property? It’s important that you know all of the options that are open to both of you.
5. DUE DILIGENCE
Although this is not unique to money lending or note investing, it’s an important step that can be easily overlooked. For transactions involving real estate, this means either inspecting the property yourself or hiring a trusted professional to. Check to make sure the property securing your note is either already owned by the debtor or is at least listed on the market. You should also look into the debtor’s financial health and history to validate your decision to do business with him or her.