By Jim Ingersoll
Are you tiring of being forced to invest in stocks, bonds, mutual funds and CDs? Are you ready to take control of your own retirement future? If you answered Yes to these questions then you are a prime candidate to add rocket fuel to your retirement account by creating great returns with alternate investments. What else could you do to boost your returns and invest now? That is a burning question that investors are asking themselves as they approach the end of the first half of 2012.
Self Directed IRAs
Recently both Warren Buffett and Donald Trump advocated investing in real estate. One investing model is to create great returns investing in real estate using a banking model. Financial editor Jean Chatzky recently highlighted Self-Directed IRAs on the Today Show. She highlighted that Mitt Romney has made effective use of his high dollar self-directed IRA account to make great some great alternate investments. Self-directed IRA’s allow the account owner to truly direct the investments into a very wide array of investment options including stocks, real estate, oil, gas and more.
The Banking System
Banks are a lot like every other business in the world. Every business sells a product or service and makes a profit for providing the product or service. The products and services that banks sell is simply money. They make money by providing loans, servicing CDs, checking accounts and other financial products.
Essentially banks use their client’s deposit accounts to enable them to make loans. If the bank has a client’s $200,000 CD account it will be able to use those funds to authorize loans such as the following: Mortgage: 4.5% APR — Credit Card: 14.9% APR — Student loans: 6.0% APR
They will likely be paying a two percent return on the CD account and then loaning against that deposit fund making between six and eighteen percent interest. To show exactly how this works would require a detailed analysis of the fractional reserve system. The bottom line is that banks make a lot of money by taking on deposit accounts and then loaning money out at specified interest rates to consumers all over the world.
The important concept is that lending money can create tremendous returns for the institution or person that lends the money. If the financial institution is providing consumer credit in the form of credit cards they will also be charging a lot of fees. The fees include annual renewal fees, late charges, over limit fees and so on.
The Credit Crunch
The past few years lenders have tightened up their lending practices and that has led our economy into a credit crunch where small businesses and individuals have a much harder time getting the capital that they need in order to continue their operations and start up new businesses.
The good news is that real estate is on-sale all across the country; the bad news is that it is still a capital-intensive business. Even though you can buy investment real estate for less than the price of a new car; a new car still costs a lot of money.
I advocate buying investment real estate without using traditional bank mortgages. In order to do that the real estate investor needs to work with individuals who want to earn great returns and essentially become their bank. Banks make great returns investing in debt and so can anyone with a self-directed IRA.
Banking Investment Model
Use your IRA as a bank and earn a passive, steady income every month for many years. You can purchase a note or create a note for someone to purchase a house. For this example, let’s loan $100,000 on a nice house and charge six percent interest for twenty years. This is similar to a bank providing a mortgage on a house, other than you will be charging a much higher rate of interest and amortizing the loan for twenty years rather than the traditional thirty years.
What is your income stream and return in this investment model one?
Loan structure: $100,000 at six percent for twenty years
Collateral: The house
Security: Deed of trust (mortgage) and promissory note will secure your interest in case of borrower default.
Monthly payment from borrower: $716.43
Total of 240 payments: $171,943.45
The cash flow income stream is $716.43 per month and it is created by loaning $100,000 on the purchase of a house. The total interest earned over the twenty years is $71,943.45 for this investment model. This is an example of a slow and steady income stream created by the loan provided.
The Keys To Making Sound Investments
Some keys to safely securing this income stream are the borrower and the collateral. If you are going to be the bank you will need to minimize your risk by qualifying both the borrower and the collateral (the house).
The borrower should be providing you with a down payment so they have some “skin in the game.” You will also want to check your borrower’s credit history. To qualify the house, you will want to be sure to get a licensed appraiser to appraiser the value of the house. Ideally, you will want lend less than the house is actually worth.
Finally, you will also want to have all of your documents prepared by a good Attorney. These documents will secure your interest in the house, name you as the mortgagee on the insurance policy and protect your interest with title insurance.
Being the bank is a nice, passive income stream. You can minimize your risk by consulting with an attorney and being careful with your due diligence process. What could you do to juice up your return in this investing model? Simply add one to three points onto the loan. In this example, that would add $1,000-$3,000 of additional profit onto the return.
What do you think of self-directed IRAs and investing in general?
“There is no better day than today to plan your future” Jim Ingersoll