How private real estate lending works

The basic idea

In private real estate lending, an individual (or their self-directed IRA) provides a loan that a bank would otherwise make. The borrower is purchasing, improving or refinancing real estate. In exchange, the borrower agrees to repay the loan with interest, and the property itself is pledged as security for the debt.

The borrower makes scheduled payments, usually monthly, until the loan is repaid. If the borrower doesn't pay as agreed, the lender has legal remedies against the borrower and, ultimately, against the property.

Promissory notes and mortgages

Every real estate-secured loan rests on two documents that work together:

• The promissory note is the borrower's written promise to repay. It sets the loan amount, interest rate, payment schedule, maturity date, late charges and what counts as a default.
• The mortgage or deed of trust (the name depends on the state) pledges the property as security for the note. It is recorded in the county's public records, which establishes the lender's lien and its priority against other claims on the property.

The note is what you're owed. The mortgage or deed of trust is what lets you look to the property if the note isn't paid.

Option A: Direct loans secured by a specific property

With a direct loan, you (or your IRA) are the original lender on a new loan. You know the property, the borrower, the loan terms and the collateral before any money moves.

How a direct loan typically comes together

1. We present a specific property and loan request, including the property's estimated value, the loan amount, the loan-to-value ratio, the interest rate, the term and the lien position.
2. You review the details, ask questions and decide, with your own advisors, whether it fits your goals.
3. At closing, funds go through a title company or closing attorney. The borrower signs a promissory note payable to you (or to your IRA custodian for your benefit), and the mortgage or deed of trust naming you as lender is recorded.
4. You should receive a lender's title insurance policy, and be named on the property's hazard insurance as mortgagee or loss payee.
5. Payments begin on the agreed schedule, either directly or through a loan servicer.

Option B: Purchasing existing mortgage notes

A note purchase means buying a loan that already exists, along with the right to receive its future payments. The original lender sells the note, and the mortgage or deed of trust is assigned to the buyer.

Whole notes vs. partial notes

• Whole note purchase: you buy the entire remaining loan. The mortgage or deed of trust is assigned to you and the assignment is recorded, so you step into the original lender's position, including the right to enforce the note and the lien.
• Partial note purchase: you buy only part of the note, such as a set number of upcoming payments or a percentage of each payment. The seller usually keeps the rest. Your rights to the collateral depend entirely on how the partial interest is documented and whether any assignment is recorded. In some partial arrangements, you may not have direct lien rights in the property.

Because you're buying a loan someone else made, the borrower's payment history, the original loan documents, the chain of assignments and the current property value all matter. We'll walk through each of them for any note we present.

Side-by-side comparison

How monthly payments work

Private real estate loans are commonly structured one of two ways:

• Interest-only: the borrower pays only interest each month, and repays the full principal at the end of the term (a "balloon" payment), often by selling or refinancing the property.
• Amortizing: each payment includes interest and part of the principal, so the balance falls over time. Monthly payments are larger, but less principal is outstanding at the end.

As a hypothetical example, a $50,000 interest-only loan at an annual rate of 9% would pay $375 a month in interest ($50,000 × 9% ÷ 12), with the $50,000 principal due at maturity. That example is for illustration only; actual rates and terms are set by each loan's documents.

Payments may be collected directly or by a professional loan servicer, which collects payments, tracks escrow for taxes and insurance where applicable, sends statements, and handles late notices. If your IRA is the lender, payments must go to your IRA custodian, not to you personally.

What happens if a borrower defaults

Defaults happen, even with careful underwriting. Here's how one generally unfolds. The specifics depend on the loan documents and on the law of the state where the property is located.

1. Late payment. After a grace period, a late notice goes out and a late charge may apply, as the note allows.
2. Contact and cure. The lender or servicer contacts the borrower to understand the problem. Many defaults are cured by bringing the loan current.
3. Workout. If the borrower can't cure right away, options can include a forbearance period, a loan modification, a payment plan, or a sale of the property to pay off the loan. These can protect value, but they can also delay or reduce payments to you.
4. Deed in lieu. In some cases the borrower may voluntarily deed the property to the lender instead of going through foreclosure.
5. Foreclosure. If needed, the lender enforces its lien. Some states use a court-supervised (judicial) process; others allow a trustee's sale under a deed of trust (non-judicial). Foreclosure can take months or longer, and involves legal fees, property taxes, insurance and upkeep.
6. Recovery. The property is sold, or taken back and later sold, and the proceeds go first to costs and then to the loan balance. If the proceeds fall short, you can lose part of your principal and interest.

Common questions