In the Search for Yield, Investors Turn to Mortgage Notes
In this low yield environment, it’s not easy to find relatively low-risk, high-return investments. But one strategy that we’re seeing PENSCO clients use to potentially add yield to their retirement accounts is to invest in mortgage-backed notes.
Mortgage notes, also known as deeds of trust, provide investors with a means of producing an income stream in their self-directed IRAs. They also provide access to the real estate market, but they can be a simpler investment to manage than buying a hard asset because they don't come with the potential headaches of being involved in the maintenance, leasing, and selling of a property.
“Depending on how they're structured, mortgage notes can also come with an interest rate that is well above the roughly 2.3% being paid on the benchmark 10-year Treasury”
Depending on how they're structured, mortgage notes can also come with an interest rate that is well above the roughly 2.3% being paid on the benchmark 10-year Treasury, and holding these notes in your self-directed IRA allows you to grow the income from the notes either tax-free if you have a Roth IRA or tax deferred in a traditional IRA.
So, what are mortgage notes and how do they work?
When you purchase a mortgage-backed note through your self-directed IRA, the IRA is performing the role of a bank in lending money to a borrower. In return for that loan, your IRA receives a note and deed of trust recorded in the county where the real property is located. The borrower pays back the principal and interest to the IRA each month until the loan is paid off, which produces a steady stream of income.
Once the loan is satisfied the IRA releases its lien on the property, giving the borrower clear title to the property (assuming no other liens exist against the property). In the interim, the recorded deed of trust offers some security in the case of borrower default because the deed of trust effectively puts a lien against the underlying property.
Buying a commercial or residential mortgage note is similar in process to buying a piece of real estate directly through your IRA. You can work with a title company and real estate broker to get help with the paperwork. But keep in mind that because of IRS rules you cannot loan money through your IRA to someone who is considered a disqualified party, like your parent or child.
While the search for yield is driving demand for mortgage notes, so too is the fact that many highly qualified borrowers still struggle to obtain conventional loans.
While the search for yield is driving demand for mortgage notes, so too is the fact that many highly qualified borrowers still struggle to obtain conventional loans. For instance, a self-employed businessperson with high income and high credit score may have a hard time getting a conventional bank mortgage and might be willing to pay higher interest rates to obtain a home loan, according to an article in The Washington Post. The same could also be true of retirees.If you don’t feel comfortable putting a loan together on your own (which requires you to find a borrower, loan servicer, and hire an attorney), you can invest in pools of notes put together by mortgage companies to create a large secured loan in which numerous parties can invest.
But before you take the leap into buying mortgage notes, talk with a financial professional to make sure doing so makes sense for your overall investment strategy and your self-directed IRA. For instance, if you're nearing retirement age, it might not make the most sense for you to invest in a 30-year note. You might consider a five-year balloon note instead, with the borrower converting to a conventional loan at the end of the note.
PENSCO’s Blog is purely for educational purposes. PENSCO does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Individuals are encouraged to seek professional advice before making any investment decision. Investments are not FDIC insured and are subject to risk, including the loss of principal.