Entrust Learning Center > Keyword: investment options > Case Study: Investing in Real Estate Notes with a Self Directed IRA

Case Study: Investing in Real Estate Notes with a Self Directed IRA

How Tom Found an Opportunity for His SEP-IRA and Helped a Fellow Real Estate Broker

Buying and selling real estate is certainly one potentially profitable way to invest the funds in a self directed IRA, but it is not the only real estate-related investment strategy.

Consider the story of how Tom’s self-directed account loaned Amy the money to fund a real estate purchase.

Using a Self Directed IRA to Invest in Notes

Our story begins with a real estate broker, Phillip, who was working to sell a property for his client. The property had been on the market for about 18 months and the seller was unhappy.

Luckily, Phillip found a potential buyer, Amy, who placed the property under contract for $350,000. Amy lined up a bank loan for $260,000, but still needed $20,000 to because she did not have enough cash for the entire down payment. Her lender was not willing to increase the amount of the loan since Amy, although employed, recently changed jobs for a higher paying position but was not yet able to qualify for the 80% loan of $280,000. Phillip was concerned that the deal was going to fall through and went to work in his office looking for solutions to this dilemma.

Enter Tom, to the rescue! Tom, also a real estate broker, was an acquaintance of Phillip’s. Phillip was aware that Tom was interested in sound opportunities to loan money to fellow brokers’ clients. Tom had an Entrust SEP IRA with a balance, at that point, of roughly $300,000.

Phillip brought Tom and Amy together, and Tom agreed to have his self directed IRA lend her money. Tom was able to negotiate the terms of the loan directly with Amy; however the actual lender documents could only be signed by Entrust on behalf of Tom’s SEP IRA. Entrust also had the funds in their trust account awaiting instructions for the investment.

Tom wanted to take full advantage of this opportunity for his SEP IRA so he offered Amy two loan options.

• Option one was to lend Amy the $20,000, secured by a second deed of trust at a rate of 12%, interest only, due in 3 years. Tom wanted a guarantee of 6 months interest and 2 points ($600) for providing this loan.
• For Option two, Tom offered to be the first mortgage lender on the property for $280,000, with a 30 year amortization, at a fixed rate of 7.825%. This was just a little higher than the bank’s current rate. The deal included a 1 point fee ($2,800) for providing the loan and a 1 ½ % prepayment penalty if paid off before year three but other loan costs were significantly less than the banks.
  

Keep in mind that Tom alone assessed the relative risk in making these loans. He also set the terms of the loans. He was well aware that his IRA administrator could not advise him on these matters.

Uncomfortable with balloon payments and unable to comfortably qualify for the bank’s mortgage, Amy decided on Tom’s second option for $280,000, forgoing the need for the second mortgage of $20,000. If she decides to refinance in three years, she will look much better to the bank and Tom will have a sound investment, secured by real estate, in his IRA portfolio in the meantime.

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