Investor Awareness - Promissory Notes

A promissory note, whether secured or unsecured, can be a great SDIRA investment. Investing in promissory notes can offer attractive returns, but also involves risks that you’ll want to make sure you are aware of. While secured promissory notes offer more protection to the lender, as they can seize the collateral in case of default, unsecured promissory notes, on the other hand, may be riskier. Investors should always conduct due diligence before buying or selling promissory notes, and we have outlined some other factors you will want to be aware of when note investing with your SDIRA. 

New Real Estate Loans 

IRAs can loan money for the purchase of real estate including property owned by the IRA, but not persons defined in prohibited transactions. The IRA should insist that the buyer complete a detailed loan application form and thoroughly verify all of the information the buyer provides. That includes running a credit check and verifying employment, assets, financial claims, references, and other background information and documentation. The IRA owner is responsible for negotiating mortgage rates and terms with the borrower. 

 Title Insurance 

When using an IRA to loan money, you should always consider having title insurance. Title insurance protects both lenders and borrowers from potential financial loss due to faults in a title to a property. Loan closings should be held in a title company or attorney’s office, and a mortgage title insurance policy issued in the name of the IRA. There are two main types of title insurance, one designed for the lender and the other for the borrower. Borrowers may buy title insurance to safeguard the lender's interest in the property. This is called lender's title insurance. The other type is owner's title insurance, which protects the buyer's stake in the property. In most cases, the seller usually pays for this type of insurance. An owner’s title insurance policy typically covers things like flawed documents, incorrect signatures, ownership by a separate party, forgery and fraud, and more. The price for owner’s title insurance generally ranges between $500 to $3,500 depending on where you live. Though it might seem like another expense, not having title insurance exposes transacting parties to significant risk if a title defect is present.  

Hiring a Loan Servicing Company 

Quest does not service the loan or generate payoff statements. If you are looking for more of a hands-off approach to keeping track of incoming payments and how much principal/interest is due, then hiring a third party loan servicer may be a great option. The IRA can hire a loan servicing company to help draw up the mortgage, mail statements to the buyers, collect payments, and otherwise administer the mortgage. If loan payments are made to the IRA, the IRA owner is responsible for keeping a record of principal, interest, and escrow.  

Pre-Existing Notes 

Pre-existing notes are also referred to as cash flows, mortgages, trust deeds,  and paper. A note is a debt, so when you buy a note, you buy a debt. A note is always written; it is never just an oral agreement. A note is signed by the payor, the party who owes the money. When you buy notes, you’re actually buying a seller-financed note. This type of note originates when a real estate owner sells property to a buyer and extends credit for any amount left owing after the down payment, plus interest. The debt is between the seller of the property and the buyer. The buyer of the property becomes the payor on the note. The seller of the property receives the payments made by the payor. You can buy the seller-held note for cash — at a discount. In most cases, you will pay less than the full amount owing on the note, and you will receive payments over time from the payor for the full amount. It’s a three-cornered relationship: you, the seller and the payor which is different than making a new real estate loan. 

What to Ask for When Purchasing Pre-Existing Notes

• Copy of note and deed of trust document or other mortgage documents 
• Verification of payment history 
• Copy of HUD statement for original purchase 
• Statement verifying types and amount of improvements/rehabs completed 
• Copy of latest real estate tax bill 
• Copy of hazard insurance policy 
• Verification of title insurance 

For more information on title insurance: 

What Is Title Insurance? Why You Need It and How to Buy It (investopedia.com)