Investing in Real Estate-Backed Notes with Your IRA

Property is used as security collateral against most real estate loans.?Non-recourse real estate loans?are no exception. When you sign a note directly with your lender the note is a Primary Market note. In the event that you purchase a note from a lender that already had executed the original note, you are said to be working in the Secondary Market. Those familiar with the financial crisis of 2008, will understand that a huge part of the bubble-burst came from asset-backed securities sold in the secondary market. Many of such junk real estate notes were sold after the loans created were known to be extremely risky. The problem with such notes is that the lender could loan large amounts to someone incapable to pay and then transfer all liability to another individual or entity on the secondary market, without reaping the consequences of the loan?s eventual default. In essence, it was a way to make large of amount of money by writing extremely risky loans and then passing the risk on to others in the secondary market. Ultimately, the entire country, including the taxpayers, took the heat for such predatory lending.

Just because asset-backed securities received a bad rap, thanks to the financial crisis of 2008, it doesn?t mean that they?re evil or avoidable at all costs. It is, however, helpful to understand the potential areas of risk when heading headlong into investing in such products. With that in mind, here is some information on investing in real estate-backed notes with your real estate IRA.

When it comes to your self-directed IRA, it is important to note that you can invest in both primary and secondary note markets.

Senior Notes vs. Junior Notes

Unless your IRA is extremely well-funded, it is advisable that you only invest in Senior Notes. Here?s why. Junior Notes represent higher risk loans: second mortgages and/or home equity lines of credit. They?re loans that are ultimately more risky because they have second claim to the property behind the senior note and are more likely to go into default. Remember, your real estate IRA is sacred. We suggest only investing in high-grade, real estate-backed senior notes.

Ultimately, the risk of the note is not just based on whether it was Senior or Junior. It is based on other important factors as well, including:

• Term of the loan. Is it a 5, 10, 15, 20 or 30 year note??
• Interest Rate. The percentage balance charged by the lender and paid by the borrower can have an affect on the riskiness of the payback.
• Creditworthiness. While credit scores and other measure are highly subjective in nature, other objective measurements help determine a person?s ability to pay (like income etc.)
• Loan-to-Value Ratio (LTV): Divide the balance of the loan by the market value of the property. This helps to measure the ultimate risk of the mortgage note. If you?re buying a note, the lower the better.

Using the aforementioned factors can help you gauge the riskiness of the note in which you invest with your self-directed IRA. When the customer?s credit score and LTV ratio are too low for a traditional bank or mortgage lender, someone with a home that wanted to borrow against it could go with a private investor for a higher interest rate. That?s where notes come into play. We will be discussing further how such mortgage notes can be structured and the best ways in which to invest in securitized obligations with your retirement account funds in later posts. Stay tuned.

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Source: http://www.silverstone.net/investing-in-real-estate-backed-notes-with-your-ira/

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