IRA Lending Blog

By Kelly Greene
The Wall Street Journal Online

In the midst of the mortgage meltdown, some lenders are actually rooting for foreclosures: investors who make mortgage loans with their IRAs.

Through a little-known tool known as a self-directed individual retirement account, individuals can pursue a wide variety of investments, from real estate to businesses. Now, at least several thousand people are trying to goose their retirement savings by using self-directed IRAs to invest in mortgages, according to companies that promote the strategy.

Typically, IRA investors aren't looking to back 30-year conventional mortgages; more often, they make loans with terms lasting from three months to a few years to fixer-uppers, small-scale developers or families who are relocating and need a bridge loan between home sales. They normally find borrowers through an informal network of real-estate agents, mortgage brokers and other investors.

IRA owners pay an annual custodial fee and transaction fees, ranging from $50 to a few thousand dollars a year, depending on asset size and activity. They typically charge borrowers a rate of at least 10%. If the borrower defaults, the IRA can wind up owning the property at a deep discount, since these deals are typically structured with the property as collateral.

"I really don't trust the stock market right now, and by doing this I can get a great return secured by real estate," says Doug Blackwell, a Phoenix real-estate adviser who set up a self-directed IRA last month with $100,000 from other retirement savings so he can fund mortgages.

For investors, one risk in foreclosing on a house is racking up so many expenses -- from legal fees to repair bills -- that the IRA runs out of money. If that happens, the IRA owner faces a difficult choice: Get a loan, or close out your IRA and pay any taxes or penalties.

Still, some IRA lenders welcome foreclosures because they increase their potential returns. No one tracks IRA loan defaults, but experienced individual lenders say it has happened rarely -- though they are bracing for an uptick, given the shaky state of the housing market in many areas.

"You don't want them to pay you," says Charlie Adams, a Houston investor who has made about 20 mortgage loans through his and his mother's IRAs in the past 10 years, typically charging 15% interest for one-year loans. "What's the worst thing that can happen -- you wind up owning a house at 70% of its cost?" He lends no more than 70% of a property's value and charges interest-only payments. More conservative lenders will go no higher than 50%.

With the one foreclosure he's done, his mother had lent $40,000 to a renovator to refurbish a house worth $85,000. The borrower made 12 months of interest payments, then stopped, and did not make the balloon payment due. Mr. Adams foreclosed on the house, his mother's IRA spent $14,000 to finish fixing it up, and they sold it in three months for $85,000, he says, adding that he helped his mother's IRA increase in value to $140,000 from $50,000 in five years.

Other lenders try to avoid foreclosures. Dennis Galbraith, who also lives in Houston, makes short-term bridge loans with his IRA, for which he says he charges 12% to 15% interest, and takes what's called "first-lien position," meaning he's first in line to get his money back from the borrower. But he's had to restructure two loans in recent months because the borrowers' "exit strategy was initially to sell the house, and it didn't work because the buyer didn't get financing approval."

Mr. Galbraith extended the loan terms so the borrowers can rent out the properties for a year and pay him off "like a normal mortgage" with the rental income. "If I choose to foreclose, I could, but I'm personally willing to work with the borrowers," says Mr. Galbraith, who works for an energy company and moonlights as a real-estate agent.

Like Mr. Galbraith, many people lending their IRA assets are connected to the residential real-estate business. Others are people phasing out of corporate careers who learn about such lending through local clubs for real-estate investors. They say that they usually connect with borrowers through word of mouth.

The maximum loan rates that self-styled IRA lenders can charge are regulated by usury laws that vary from state to state. In California, for instance, interest rates are typically capped at 10%, says Hugh Bromma, chief executive of Entrust Group Inc. in Oakland, Calif., which administers self-directed IRAs.

Self-directed IRAs make up less than 2% of the overall $4.2 trillion IRA market, but they are increasing in popularity. And the handful of firms that handle such accounts are logging increased usage by self-styled mortgage lenders.

Two thousand of the 40,000 self-directed IRAs handled by Entrust are making real-estate loans, and the average account is valued at $250,000, says Mr. Bromma. The number of accounts with such activity has doubled each year since 2005.

The story is much the same at Pensco Trust Co. of San Francisco, where about $367 million of the $2.2 billion in IRA assets it has in its custody has been lent for real-estate deals.

Guidant Financial Group Inc. in Bellevue, Wash., sets up limited-liability companies through which IRA owners invest in accounts with an average value of $180,000. It says it has seen interest in lending, mainly for real estate, increase 20% in the past two months.

With a self-directed IRA, you can invest in things other than mutual funds, such as rental property, businesses or community-bank stock -- just as long as any profits go to the IRA and not your regular bank account. (You're also prohibited from using the property as a personal residence.)

Entrust charges IRA owners $250 a year to invest in one mortgage, or $2,000 a year for unlimited transactions. Setting up a Guidant account costs $130. IRA lenders also have to pay other mortgage loan costs, including escrow and closing fees. At least some of those costs, though, usually can be passed along to borrowers.

Another risk to investors is running afoul of the Internal Revenue Service's rules for IRAs. "You cannot take any kind of fee from your IRA for doing something inside your IRA, and if you have to start using money from other sources to bail out something happening with the loan inside the IRA, that's a big problem," says Natalie Choate, a Boston tax attorney. So it's important to make sure the IRA has enough money in it to pay any legal fees involved in foreclosure, or property taxes and insurance costs if you wind up owning a house for a while before you can sell it.

The IRA can borrow to pay those costs, Ms. Choate says, but doing so creates taxable income and complicates your tax return.

Don Baglien, a truck-stop manager in Roseburg, Ore., recently rolled over $100,000 from a former employer's 401(k) to a self-directed IRA because "I'm just too busy to follow the stock market closely and stay on top of it," he says. After attending a Guidant seminar, he set up an account and recently made a second-mortgage loan, with a two-year term and 20% interest, to a local pizza parlor in need of repair. So far, it's borrowed $40,000 for a new heating-and-air-conditioning system and roof, he says. The restaurant owner owes $900,000 on the building, appraised at $1.3 million, "so I definitely felt like there's some equity there.

"If he doesn't pay, I guess I'm going to be eating an awful lot of pizza," Mr. Baglien says. "Hopefully, they'll still have some beer left."

Yes, you can refinance a property you currently own in your Self-Directed

IRA with a non-recourse loan.  NASB allows an IRA to take the equity

out of the property and put liquid funds back into the IRA.  This allows

the account holder the opportunity to improve the property or purchase

more assets in the Self-Directed IRA.  NASB typically lends up to 70% of

the original purchase price or 50% of the current value, whichever is less.

Please contact NASB at 1-866-735-6272 if you have questions about this loan

option. 

IF your retirement garden — specifically your individual retirement account or IRA — hasn't been growing fast enough to meet your future retirement needs, you might want to join a club of contrarians: those who have decided to take matters into their own hands. Literally.

Self-directed IRAs are billed as "putting the 'I' back in IRA." They let individuals determine what, when and where to invest their retirement money. And they are catching on — in no small part thanks to the stock market's volatility and the real estate market's recent riches.

Real estate has always been permitted in IRAs, but few people know about this option. Financial institutions — mutual funds, stock brokerages, banks — are typically where IRAs are held. But investments in other things, most notably real estate, are fully permissible under the Employee Retirement Income Security Act of 1974. It prohibits retirement plans from investing in just two types of investments — life insurance contracts and collectibles. Everything else is fair game.

But ERISA or no, the other thing standing in your way may be your employer. If your IRA is held in a company plan through your job, the plan's guidelines may specify what type of investments can be made — and real estate is rarely among them. If this is the case, establishing a self-directed IRA isn't an option until you and your employer part ways. Once you leave, no matter the reason, you can roll over the funds in your IRA and 401(k) to a self-directed IRA.

It is estimated that only about 4% of America's retirement funds are held in nontraditional accounts, including IRAs invested in real estate. But the trend, experts agree, is toward more money being funneled into these little-known, little-used, self-directed IRAs.

Although investors use self-directed IRAs for a variety of investments, among nontraditional accounts, real estate is by far the most popular.

It certainly was the motivation for Anthony Moreno, 56, of Oceanside, Calif., to establish his self-directed IRA.

Moreno retired in July 2005 after working more than 24 years as a nuclear computer technician at San Onofre Nuclear Generating Station. When he left Southern California Edison's employment, he initially left his pension and 401(k) with the company — primarily because he didn't know what else to do with it, he said. But concerns about a low rate of return and a lifelong desire to own international real estate led him to research self-directed IRAs with the idea of putting his money into real estate. Opening one simply made sense for him, he said.

Now Moreno is in escrow on a pristine 68-acre private island 300 yards off of Roatán Island in the Caribbean Honduras. It was listed at $850,000, and he plans to develop a day resort on it, ferrying cruise-ship passengers by private speedboat to his island. Carnival Cruise Line is building a $50-million terminal at Roatán Island that will be able to accommodate two mega-ships and 7,000 passengers a day, and Moreno plans to tap into this burgeoning tourist market.

Moreno's self-directed IRA was set up by Guidant Financial Group, which specializes in facilitating real estate investments using an IRA.

"I don't see it as gambling," Moreno said of investing his retirement funds in this venture, although he acknowledges that "conventional thinking would probably view this as very risky for someone of my age" and that "there are many 'safer' investments which I could have chosen." But, he added, none of those other investments had "the potential for making my dreams come true."

"I don't know of anybody who ever realized a dream by allowing their fears to prevent them from giving it their best shot. Regardless of the outcome, I will never regret going for my dream. If I hadn't tried, I would have always wondered: What might have been?"

As romantic as the idea of buying your own island sounds, many caution that real estate purchases made through self-directed IRAs aren't the answer to everyone's investment goals. Experts, such as Jeff Nabler of the IRA Assn. of America, strongly urge people to consult a professional advisor before moving their money into one.

For one thing, the tax laws concerning self-directed IRAs are complicated — and likely beyond a layman's interpretation. Mistakes can be costly; early withdrawal penalties may be imposed if funds are misused.

The Internal Revenue Code 4975 defines what are prohibited transactions for IRAs, said David Nilssen, chief executive of Guidant Financial Group, a Washington-based company that he says is rolling over about 200 accounts each month. Basically, any investment the IRA participates in must be for the exclusive benefit of the IRA, Nilssen said.

For instance, you can't use your IRA to buy a home for your mother to rent because there might be a conflict of interest to act in the best interest of the IRA (eviction) should Mom fail to make the rent payments.

For the same "exclusive-benefit" reason, self-directed IRAs cannot be used to purchase a principal residence or a vacation home. They can be used to buy income property, such as land or an apartment building. The title to the property would be held by a custodian, who acts as a trustee for the account and does not offer investment advice but functions essentially as a conduit for your wishes as they relate to buying and selling. The custodian would collect rent checks, pay the mortgage and taxes and handle the other financial aspects of your ownership — for a fee.

The fees vary, and investors are advised to check them carefully and do some price-comparison shopping before moving IRA money from a traditional fund to a self-directed one.

In the last seven years, Guidant's Nilssen said, the self-directed IRA industry has "exploded." Before 2000, "investors couldn't justify leaving the stock market because it was performing too well," Nilssen said. "The industry has more than doubled since that time."

Self-directed IRAs can produce great returns, Nilssen said, but he too cautioned that there are specific guidelines an investor must adhere to. "This is why we recommend that people not try to structure these investments themselves without the help of a qualified professional."

are unlimited...you can buy real estate, cattle, start up your own business,

and offshore property.  There a 3 things the IRS won't allow in a Self-

Directed IRA:

1. Life Insurance

2. Collectibles such as cars, stamps, and furniture.

3. Stock in a "S" Corporation

That's it!  Everything else is acceptable in a Self-Directed IRA. 

NASB focuses on real estate in an IRA.  We provide non-recourse loans

for single family homes, 2-4 units, condos, townhomes, and multi-family

units (5 +).  Please contact NASB at (866)-735-6272 for more

information about non-recourse loans and how you can use leverage to

bolster your gains.  

A borrower doesn't qualify for a non-recourse loan when they purchase real estate in their Self-Directed IRA. NASB won't require the borrower's tax returns, W2's, paystubs, or employment info. Everything is contingent on the property and cash flow. Credit scores don't have an impact on the rate or approval. The appraisal is the most important component NASB will look at during the non-recourse loan process. NASB requires a full appraisal with rent schedules to verify going market rents in the area for similar style properties.

The fourth item states that the IRA can not be used as security for a loan.  Most loans are recourse loans.  The borrower/account holder sign a personal guaranty at closing.  This allows the lender the right to recoup any losses from the borrower that weren’t recovered from the foreclosure sale.  

Non-recourse loans are just the opposite.  There is no personal guaranty signed at closing.  The security for the loan is the property itself not the Self-Directed IRA or the individual.  The lender can only recover the property in case of a foreclosure.  They have no recourse against the Self-Directed IRA or the account holder.

Just remember that a Non-Recourse Loan absolutely has to be used with an IRA if financing is desired.  Without one, the transaction is considered prohibited and can trigger a penalty for the account.