Private Lending | The Entrust Group

Private lending is an opportunity to invest in debt-based financial instruments, or loans. A loan investment made by a Self-Directed IRA (SDIRA) requires the creation of a promissory note. A promissory note is a written promise to repay debt under specified terms. These specific terms usually involve a declared timeline, series of payments, or funds due upon demand. They can also include an interest rate and written consequences that will occur if the borrower defaults.

One of the advantages of owning notes is a steady income stream. You can look forward to regular deposits into your Self-Directed IRA, where the income will grow tax-free (in a Roth IRA) or tax-deferred (in a Traditional IRA). The income received from a note is truly passive.

A loan investment made by a Self-Directed IRA (SDIRA) requires the creation of a promissory note. A promissory note is a written promise to repay debt under specified terms. Unlike private equity, a loan is repaid with interest rather than as an investment in exchange for shares of a company.

When considering debt-based assets, you might also hear the terms performing and non-performing notes. Quite simply, performing notes are notes that are being repaid according to the loan terms, while non-performing notes are loans where the borrower is in default. Just like any investment, it is important to do your due diligence and understand the terms and status of any debt-based asset you invest in.

Types of Loans

Personal Loans

Personal loans can be used for virtually any purpose.
Some of the most common uses include debt consolidation, home improvements, medical bills, and tuition.
The lender takes on more risk with a personal loan since there is no collateral securing it.

Business Loans

Companies can use a business loan/promissory note as an alternative method of obtaining credit when they have exhausted other options. Promissory notes issued by a corporation typically carry a different level of risk due to the fact that the note is backed with corporate stock as the collateral.
Depending on the success of the company, the value of the collateral can increase or decrease.

Mortgage Notes

These are promissory notes that specify the amount of the mortgage loan and the borrower’s promise to repay it. These notes are secured by property. If the borrower defaults, the lender can foreclose on the property to satisfy the loan. A deed of trust or mortgage deed is created once the parties agree on the terms which the lender will hold onto until the loan is paid in full. There are two types of mortgage notes: performing and non-performing notes. If the borrower makes their payment on time, the note is performing, if they don’t, the note is non-performing.

Investors who want to invest in real estate without the hassle of owning a real estate property tend to appreciate the benefits of mortgage notes. Owning the note rather than the underlying property also leaves you with a much more liquid investment. You can sell the note to another investor with relative ease (and speed), whereas offloading real estate takes considerable time, planning, and effort.

Equipment and Automobile Financing

Your SDIRA can invest in a loan that provides financing for the borrower to purchase a new vehicle or equipment.
The vehicle/equipment becomes collateral and can be seized in the event of nonpayment.

The Difference Between Secured and Unsecured Notes

Secured Notes

Secured loans are backed by collateral. The borrower pledges certain assets which can be seized by the lender if the borrower defaults on the loan.

Unsecured Notes

Unsecured loans are not backed by collateral and are considered riskier than secured loans since there is no material recourse if the borrower defaults.

Convertible Notes

Notes that are convertible can be exchanged for equity assets by either the owner of the security or the entity responsible for issuing it. This transition is frequently made if an institutional investor purchases an equity interest in the financial entity that issued the note. These notes are considered a type of short-term debt financing and are often used by seed or angel investors looking to fund an early-stage startup.

Avoiding Prohibited Transactions

Your IRA cannot issue a loan to a disqualified person; the act of doing so is called a “prohibited transaction.” Your IRA is also unable to issue a loan that benefits a disqualified person, as this would result in a self-dealing prohibited transaction.

Examples:

You loan your son $50,000 from your IRA.

You use IRA funds to issue a loan to a company at which your granddaughter is a shareholder.

Steps to Lend Money With an SDIRA

START

STEP 1

Open a Self-Directed IRA

Open an account online in under 10 minutes here.

STEP 2

Fund your account

Via a transfer, a rollover or a cash contribution.

STEP 3

Find your investment

Find an individual or entity interested in borrowing money from your account. Make sure you’ve done your due diligence on the borrower.

STEP 4

Initiate the note

a. For a private lending note: Complete an Alternative Asset Investment Request on the portal OR fill out a Private Lending Buy Direction Letter for Entrust to request the funds.

b. For mortgage notes: Complete a Real Estate Note Investment Request on the portal OR fill out the Real Estate Note Buy Direction Letter.

STEP 5

Entrust processes the transaction

Entrust reviews your form and all documentation to make sure it’s compliant.
Once forms and documents have been reviewed and accepted, Entrust sends funds to your borrower or title company (for mortgage notes only)
The asset is now booked into your Entrust Account*.

*Note: For mortgage notes, please send the original Promissory Note and Recorded Deed of Trust/Mortgage to Entrust for recordkeeping.

FINISH

Your SDIRA now holds your note!

Why Invest in Private Lending?

When you want flexibility and the opportunity to invest in smaller businesses or more personal projects, private lending makes that possible. If this is one of your top investing priorities, you may be a Community Builder. Compared to the other five types of investors, Community Builders are focused on making a positive impact with their portfolio, often at the local level.

You have the ability to seek out investments that fit with your goals and earn interest on the money that you lend. Private lending is a popular strategy for people who want to earn passive income. Lending money to someone investing in real estate or business allows you to get in on the action without having to purchase the property or manage the day-to-day affairs of the business.

Private lending is also a good option for people and small businesses to acquire capital without using traditional lenders. Because private lending does not go through traditional loan channels, the money can be available more quickly.

It can also work well when someone cannot qualify for a traditional loan. Because of the higher level of risk and the difficulty of recovering the capital in the case of default, these types of personal and commercial loans are often shorter terms and offered at a higher interest rate than a loan acquired through traditional lending.

What Type of Loans Can You Invest In?

Mortgage notes are one of the most popular private lending investments. Using private lending to invest in real estate is a win-win for lenders and real estate investors. Private lenders can reap the benefits of a real estate project without taking on the whole project, and investors can get the capital they need quickly and without the hurdles that a traditional lender might have in place.

There are endless options. It can be a good choice for investors who want to lend money to help a small business get off the ground or to provide purchasing power for a business to acquire more inventory as they grow. Private lending can also be used for personal loans, buying automobiles and machinery, educational expenses, or even helping someone pay off debt.

What’s the Process to Invest in Private Lending with an SDIRA?

In order to loan money from your SDIRA, you will need to create a promissory note. A promissory note allows you to dictate the terms of the loan, the repayment timeline, an interest rate, and even what happens if the borrower defaults or does not repay the loan according to the terms. You are responsible to decide if the note will be secured or unsecured. Just like any investment in an SDIRA, the account holder is responsible for all the due diligence when researching any investment.

To brush up on you due diligence skills, download our Self-Directed IRA Due Diligence Guide. Inside, we've included dozens of questions to ask before considering adding any new opportunity to your SDIRA.

Self-Directed IRA Due Diligence Guide

Download Now

If you already have an SDIRA, then you’ll be glad to hear that using your SDIRA to lend money is similar to other investments.

Once you have funded your SDIRA, you are ready to invest.
Do all the necessary due diligence when selecting investments.
Draw up the loan specifics such as a timeline for repayment and terms.
Initiate the note investment.
- For a private lending note (any note but mortgage notes), complete and submit an Alternative Asset Investment Request on the Entrust Client Portal.
- For a mortgage note, complete and submit a Real Estate Note Investment Request on the Entrust Client Portal.
Entrust will review all your documentation to be sure everything is compliant.
Once everything is accepted, Entrust will send the funds to your borrower.

If you don’t already have an SDIRA with Entrust, it’s easy to get started. Go to our Open an Account page and follow our easy online steps. If you’d like to read about ways to fund your account, we have an article about the differences between transfers, rollovers, and contributions so you can choose the method that is best for you.

What Are the Rules for Investing in Private Lending?

If you are using your SDIRA to loan money, you have to remember that all the rules and regulations when investing with an SDIRA are still in force. You cannot engage in prohibited transactions or lend money to a disqualified person. This includes not lending money to businesses owned by disqualified persons. Be sure to check out our guide on the rules and regulations to make sure you are preserving the tax-advantaged status of your SDIRA.

The potential for passive income through private lending is at your fingertips with an SDIRA from Entrust. If you have other questions, you can always go to our private lending page, or schedule a one-on-one consultation with one of our knowledgeable staff members.

Or, if you'd like to learn more about specific private lending assets, watch a replay of our recent webinar, What You Should Know About Real Estate-Backed Lending. In this session, we spoke with Dave Goldberg from the Investor's Source for a 101 education on trust deeds.

In essence, trust deeds are a way to use real property as security for a loan, much like mortgages. The key difference is that mortgages involve two parties: the borrower and the lender. In contrast, deeds of trust involve three parties: the borrower, the lender, and a trustee. Learn more about the potential pros and cons of this asset in our webinar replay below.

If you are partnering your IRA with personal funds, both you and your IRA are the lenders. In this case, you need to add the percentages of an ownership interest to the title.

For example: The Entrust Group, Inc. FBO John Smith Account #12345, [Percentage of ownership] % undivided interest.

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