A few weeks ago, I suggested that our clients who are interested in divesting themselves of the Real Estate in their self-directed IRA turn those assets into paper. This would provide continued income through a note created from the sale of the Real Estate.
We received a lot of positive feedback from this article along with questions regarding owner financed notes as an investment for a self-directed IRA.
I would like to provide some basic information on seller financed notes. I am not suggesting that this is the perfect investment, but I would like to make clients and prospects aware of their investment options. As always, our clients make their own decisions on which type of investment makes sense for them and their IRAs.
What is an Owner Financed Note?
A Promissory Note is an IOU. Let’s say Mark purchased a property for $100,000 from Sue. He put $10,000 down and Sue, as the owner of the property, financed a sale for $90,000. He signed a Promissory note, which states that he promises to pay the $90,000 over 30 years at 5% interest.
If he defaults on his payments, the security interest in the form of a mortgage, deed of trust or land contract (depending on state where the note was originated) allows Sue to foreclose on the property as the promise of repayment was broken. Therefore, thanks to the security interest, Sue has the legal right to get the property back.
Several months go by. Mark is making his payments on time. Sue, however, needs to raise cash due to a financial crisis. She decides to sell the note to Sam, an investor she met at a real estate meeting. He buys this note for $80,000 with his self-directed IRA. He receives the payments for the remainder of the 30 years as originally promised; however since he bought the note at a discount, his yield will be much higher than 5%.
The payments coming into Sam’s IRA are tax-deferred, or in the case of a ROTH IRA, tax-free. This allows Sam to compound his wealth with a discounted note. If he needed cash Sam could sell the entire note, or a part of the note depending on his financial needs, and still have the opportunity to capitalize on a payment stream for some period of time.
The note business itself is alive and well thanks to the lending requirements of the banks these days. Acquiring a privately held mortgage secured by a solid piece of real estate from a borrower who could not get a bank loan is growing in popularity.
As with any other investment, performing due diligence and assessing the payment history of the borrower is the key to determining what the investor will pay for the note.
By knowing a little about the note business, you can enhance your IRA investing options. Feel free to contact us through our website at www.irainnovations.com should you have any questions or if you are ready to open an account and get started. Utilizing alternative strategies helps diversify your portfolio. We want to be your source of education and administration for your self-directed IRA. Feel free to connect with us on LinkedIn or bookmark our site for more information on investment strategies for your IRA!