09/24/2014 09:25 am ET Updated Nov 24, 2014

Been Borrowing All Your Life? Retire as a Lender

Let's face it, we're a consumer society, and much of our consumption over the past decades has been financed with debt. Our interest payments have financed some nice lifestyles and created fortunes for banks and conglomerates. If you're in or nearing retirement, you may still be paying a mortgage, a car note or two, and maybe even some consumer debt payments. Even if you've managed to get free of much of that debt, your income from investments can't be looking all that great right now.

A recent check of the "safest" bond investments, Treasuries, showed yields under 2% on 5-year bonds. If you're more daring, junk bonds pay significantly higher yields. But, they've broken down through 5% now, and there's a lot of fear when even the most risky yields are that low. A half million dollars in a retirement account yielding a safe 1.80% is throwing off only $750/month before taxes. There are plenty of articles out there about rental property investing, and it's a great way to go if you're up to the hassle and moving your assets into a self-directed account.

After all, if you owned five $100,000 rental homes with that half million dollars, each could be renting out at around $750/month, five times the return before taxes of those bonds. Rental properties aren't hands-off investments, and it's easy to get really sick of late night tenant plumbing problems and unexpected maintenance expenses. The good news is that rental property isn't the only way you can profit from real estate in a self-directed retirement account.

There aren't as many choices for IRA and 401k custodians for self-directed accounts. And there are even fewer if you want to pursue different strategies. It can be well worth the search however. It's not widely advertised, but you can lend money under the right circumstances and collect interest in your self-directed retirement account. You can turn the tables and become a collector of interest instead of a borrower.

You can issue short term mortgages, but there are other higher yield opportunities out there. Funding real estate investor deals can be really lucrative. There are companies that specialize in what is known as "transactional funding." They loan money to real estate investors who are wholesaling or flipping properties. These loans can be for a few months while a home is in the rehab process before a flip, or they can be for a few days or even hours. Let's see how it works:

• A real estate investor who is wholesaling properties locates deep discount deals and flips them to rental investors if the homes are in livable condition.
• If the home needs work first, they can flip it to a rehab "fix & flip" investor.
• In both of these cases, they may seek funding to close on their purchase of the home from the distressed seller until their flip to the other investor closes.
• In some cases these deals close the same day, or often in just a few days or sooner.
• The funding is secured by the real estate.
• There's a lot of money to be made in a very short period of time with these deals, and the investors consider it a cost of doing business and factor it into their deals.

How much money are these lenders making? Rates and fees are varied, but one example quote from a transactional lender website shows: a minimum $1,000 for small deals, or 2% up to $250,000 and 3% over that, plus $495 per deal. Remember that we're not talking about annual interest rates here. It's a fee, and it is paid at the closing of the second deal, which means that the principal and the ROI are back in the account within a day or so in many cases. A chart from another lender shows fees for deal amounts like this:

Amount Loaned Fees

$80,000 $1,200
$150,000 $2,250
$350,000 $4,375
$1,000,000 $10,000

Even if you're funding rehab and fix & flip deals, you can do quite well over a longer time frame, as the fees and interest rates increase to cover your risk. As with any other investment, there are risks, but you do have the security of the value of the real estate, and most of these lenders will only advance up to around 60% of the value of the property. This way they hope to recover their money if they must sell the home due to default. Of course, there is some really important due diligence that must happen:

• Work only with seasoned investors, and check their track records. A series of profitable deals indicate a successful business plan.
• You want to see both contracts: the purchase contract for the property, and the contract with the investor's buyer showing everyone's profit in the deal and covering your investment.
• Work only through reputable title companies or closing attorneys.
• And, if it's through a retirement account, you have a whole new set of IRS hoops and rules, so make sure your custodian is experienced and ALL funds move through the account.

There are some nice rewards from short term lending like this, but there is a great deal of preparation before the first dollar moves. You may want to join a local real estate investment club and get to know some of the investors. There will be investors in these clubs seeking funding.