Find out how you can diversify your investments with a mortgage promissory note using your self-directed IRA.
In this article:
- Self-Directed IRAs’ Edge
- What Is a Promissory Note?
- What Does It Mean to Buy a Mortgage Note?
- Buying a Mortgage Promissory Note with Your Self-Directed IRA
Mortgage Promissory Notes: How to Get One with Your Self-Directed IRA
Self-Directed IRAs’ Edge
One of the benefits of self-directed IRAs, when compared to conventional IRAs, is that they allow you to explore alternative investments. Standard IRAs limit you to typical investments, such as stocks, bonds, and mutual funds.
Self-directed IRAs open whole new worlds of investment opportunities. These opportunities include real estate, private equity, gold, and even a mortgage promissory note.
What Is a Promissory Note?
Many people confuse a mortgage with the promissory note.
The promissory note is the promise of borrowers to repay the amount they borrowed to purchase their homes. The mortgage, or “deed of trust” in some states, is the document allowing lenders to place liens on homes, so they can use the home to secure the loan.
You need both the mortgage lien and the promissory note to secure a loan large enough to purchase the average home.
What Does It Mean to Buy a Mortgage Note?
Mortgage notes are attractive to many investors seeking easily liquidated assets to add to their portfolios. Investors have the option of choosing between traditional mortgage notes from banks and financial institutes or private mortgage notes.
When you purchase a mortgage note from a bank or a private lender, you are buying the borrower’s obligation to repay the loan. It’s an attractive option for investors for many reasons, including the following:
- The loan is secured.
- It will continue to pay off over time.
- The odds are good that borrowers will either sell or refinance within the next five to ten years, creating an early payoff.
- The notes are fairly easy to liquidate if the note buyer needs fast access to cash (though there may be penalties for doing so if you purchased the note with your self-directed IRA).
Because notes are easily bought and sold, it is an investment that doesn’t require a large amount of time to make either.
Buying a Mortgage Promissory Note with Your Self-Directed IRA
Once you make the decision to invest in real estate notes, your next step is to make the purchase.
You need to have a well-funded self-directed IRA with which you can purchase the promissory note. It must be a self-directed IRA because conventional IRAs do not allow the purchase of real estate or real estate notes with the funds.
The next step is to find the note you wish to invest in. According to IRS rules, you cannot buy notes from yourself, family members, or those who are designated IRA beneficiaries.
The goal is to identify mortgage notes that offer the greatest potential for a favorable return on investment. Once you purchase the note, you do not own the note. The IRA does. It must be one that benefits the IRA.
Attractive promissory notes to purchase include notes where borrowers made higher down payments and have built a substantial amount of equity in the home at the time you purchase the note. While those with higher interest rates may be appealing, they often carry greater complexities. Proceed with caution, though.
Once you’ve identified the note you wish to purchase, often through mortgage note brokers or even via online mortgage note marketplaces, you must prepare and submit a ‘Real Estate Note Buy Direction Letter’ along with supporting documentation (promissory note, deed of trust/mortgage deed, and preliminary title report from the lender).
Investing in mortgage notes with your self-directed IRA is a great way to add diversity to your portfolio and a nice feather to your retirement nest egg.
Have you ever considered acquiring mortgage promissory notes? What will push you to go on with it? What will hinder you from doing so? Share with us your thoughts in the comments section below.