Investing in Trust Deeds Using a Self-Directed IRA
By: Brock VandenBerg, President THOR Financial, Inc.
IRA & 401(k) Insights
Trust Deeds can be an excellent vehicle when seeking an investment option that offers consistent monthly cash flow. In fact, more investors are moving to trust deed investments because they offer greater yields than more traditional “income focused” investments such as a saving account, bank CD, or high grade bond. Further, trust deed investments provide an investor measurable risk, which is imperative in today’s volatile economy.
A trust deed investment is simple. The trust deed investor is acting in the capacity of a lender and is lending money to a borrower using real estate as collateral. The loan is secured with a Trust Deed which is recorded against the collateral. The terms of the loan are detailed in the Promissory Note.
Understanding the risk of trust deed investing is imperative for long term success. The security for your loan is the collateral securing the trust deed. Therefore, it is imperative that there is sufficient equity between the amount of the loan and the value of the real estate (which is called the “loan to value” or LTV). In the unfortunate circumstance that you are forced to foreclose on the collateral, the collateral should have sufficient value upon sale to return your original investment, outstanding interest due from the borrower, and any additional fees / costs resulting from the foreclosure.
An additional factor that is important in investing in trust deeds is recognizing your position as a lender. Investing in a 1st trust deed means you are in a superior position to any junior liens (2nd or 3rd trust deeds). As a result, the proceeds from the sale of the collateral will first go to the 1st trust deed, then the 2nd trust deed and so forth. It is critical to know the position of your trust deed and consider what would occur upon the sale of the collateral if you are not in 1st position.
Let’s use the following example to explain how a trust deed investment is structured. Mike Borrower is seeking capital to acquire a bank owned property ($50,000) as an investment rental. Mike cannot get a loan from a traditional lender because they are not lending on real estate investment property. Jane Lender agrees to lend $25,000 to Mike Borrower to acquire the property at an interest rate of 10% per year. The loan is to be secured by the property being acquired and in 1st position.
In the scenario above, Mike Borrower is happy because he is able to acquire the property. Jane Lender is happy because her investment, which is secured by a 1st trust deed at 50% LTV ($25,000 loan / $50,000 property value = 50% LTV), earns a 10% annual yield. Based upon how she structured the promissory note, she will earn a monthly income equal to her annual yield which far exceeds the return she would have earned on her savings account or a CD.
When investing in trust deeds, it is imperative to obtain the following. Order a 3rd party appraisal or valuation of the property. Because your investment is secured by the underlying real estate, you will want to verify that the value of the collateral is sufficient to return the principal on your loan. Additionally, obtain a Title Policy from a reputable title insurer that insures your trust deed on the property. Lastly, verify the borrower has a Property Insurance policy on the property and request verification that it names you as a “Mortgagee.”
Finding Trust Deed investment opportunities is easy. First, you will want to define the types of real estate you feel comfortable lending against. Second, locate a local real estate broker that specializes in trust deed investments. When selecting a trust deed broker, do your due diligence by asking for references, requesting a schedule of loans that they have funded, and confirm the status of their license. Lastly, use common sense. If something doesn’t seem right about a borrower or the loan, go with your gut and move on.
Trust deed investing is an excellent investment strategy to earn consistent monthly cash flow. Using appropriate investment techniques, such us understanding the collateral value, recognizing your loan position on the property, and obtaining title, property insurance may lead you to long term success.
By Brock VandenBerg, President
THOR Financial, Inc.
If you’d like to learn more about Trust Deeds, join Brock VandenBerg and Entrust’s Brian Davis, as they host the next installment of our National Webinar Series entitled “Investing in Trust Deeds With Your Self-Directed IRA.” It happens Tuesday, November 8th at 10 a.m. PDT.
Register Now.
FUZE