Red mud is a hazardous waste of alumina production. Currently, the total accumulated amount of red mud is over 4 billion tons. The promising method of red mud processing is carbothermic reduction of iron at 1000–1400 °C into metallic form followed by magnetic separation. In this study, the mechanism of carbothermic solid-phase reduction of red mud was investigated. Based on the experimental data, the two-step mechanism of the first rapid stage of the process was proposed, which leads to almost full iron reduction. The estimated value of activation energy has indicated that solid-phase diffusion is a rate-controlling step for this stage. However, almost full reduction is necessary, but insufficient factor for successful magnetic separation. The second crucial factor of the process is enlargement of iron grain size, which leads to gangue-grain release during grinding and increases efficiency of the magnetic separation. The prediction model of iron grain growth process during the carbothermic reduction process was suggested. The calculation of average size of iron grains formed during reduction process that performed according to the assumption of diffusion-controlled process showed their correlation with experimental data. Various methods were proposed to promote the process of iron grain growth during carbothermic reduction of red mud.