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October 4, 2018

Self-Directed Investment Series: Private Loans

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In the next few weeks, we will be going over some of the more popular investment options for Self-Directed IRAs and Solo 401(k)s.  Today, our focus is on private loans:

The term “personal loan” has a distinctively untrustworthy feel about it. You make a personal loan to your brother-in-law of $2,000, and then you never hear from him again. (Some might call that an investment.)

However, tweak the term just a little bit and call it a “personal mortgage”, and all of a sudden you have a viable product. Why is that? Because a mortgage is not an income producing loan whose repayment is backed by the ever faithful assurances of the borrower. A mortgage is an income-producing loan that is backed by the property whose purchase it is facilitating.

That means that your loan has a nice degree of security. If the borrower defaults on the loan, you can go to the property to collect your outlay. In fact, some investors specialize in personal loans with the expectation that some of the deals will fall through and they’ll be able to snag a property at a rock bottom price.

If this is the route that you choose to go with your self-directed funds, then you should keep two things in mind:

  1. The first is to make sure your contract says exactly what you need it to say. This is normally the domain of the real estate lawyers, and you should find one you trust to draw up the contract.
  2. The second is to be prepared if things don’t work out the way you hoped. Let’s say the loan defaults and you get the property. Great, right? You throw up a “For Sale” sign, and wait for the offers to start pouring in.

Then you wait some more.

And some more.

At some point you begin to panic because all of a sudden the realization hits you that you have sunken a large portion of your retirement funds in a property that you can’t sell. Now what?

Certain situations have no easy answers. The best thing to do is to never get into that situation in the first place. If you want your retirement funds to get into the personal loan business, then it means you need to gain some familiarity with real estate in general. There are different factors to be considered when assessing a property for investment.

The best thing to do is find a mentor. Go to a local real estate investors group and listen to what people have to say. Then ask somebody who knows what they’re doing and listen to them also. Then do a lot of research on the specific property. Now, take a break and have a cappuccino. Okay, now decide whether or not it’s a good deal. (And if it was a good cappuccino, let me know. I have yet to find the gold standard.)

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