One option investors often choose in self directed IRAs is investing through promissory notes. A promissory note is a signed agreement promising to pay a person or business a certain amount— with interest and a maturity date. There are so many strategies used by investors, from buying and selling notes to acting as the lender on real estate deals (often known as mortgage notes). Today, we'll be covering promissory notes (but not those secured by real estate)— here's the process to get started:
What Is A Promissory Note?
A Promissory Note is a signed agreement, where one party (the borrower) is promising to pay a specific person or business a certain amount (the lender) with interest and a maturity date. In the case of investing in notes with your self directed IRA, the IRA would be the lender, essentially acting as the bank. They have many names, depending on the situation, and you may hear them called a number of things: personal notes, loan agreements, or secured/unsecured notes, to name a few.
What Are The Different Types of Promissory Notes?
The two main types of notes are secured and unsecured:
A secured note is a note that guarantees collateral in case of default, meaning the lender can make attempts to recoup their investment in the event the borrower cannot pay back the loan. This is especially common with real estate investments, where the note is secured by the property itself.
Be aware of the terms of your note and see that your borrower understands their portion of the agreement. If your note is secured, make sure the borrower is clear on what happens in the event of default, along with their obligation to maintain the property held as collateral.
An unsecured note is a promissory note where nothing is held as collateral— meaning you won’t have much recourse if the borrower defaults on the loan. These loans typically have higher interest rates and higher monthly payments, along with a more lengthy pre-loan vetting process, to try to make up for this risk— but they do come with risks.
Who Can I Loan Money To?
As always (or almost always) when investing with your self directed IRA, you need to be aware of IRS rules on prohibited transactions and disqualified persons. Your IRA cannot loan, borrow money from, or engage in any transaction with a disqualified person— or your IRA could lose its tax-advantaged status and be force distributed.
How Do I Do It? Step-By-Step Process
Open & Fund Your Account
To open your account with IRA Resources, you'll need to complete and submit our Account Application and General Fee Disclosure, along with a clear copy of a government-issued ID or passport.
Once open, most clients transfer their funds to IRA Resources— to do this, you'll submit our Transfer Form along with an account statement from within the past six months. If your funds are coming from a qualified employer plan, you'll need to rollover your funds— this must be initiated by you, by submitting your current custodian’s rollover paperwork to your current custodian. If you have any questions over which method is right for moving your retirement account, an IRA Resources representative would be happy to help.
Once your account is open and funded, the next steps are to fill out our paperwork and submit your promissory note.
To fund your investment, we need:
- An IRAR Buy Direction Letter— the specific form depends on the terms of your note.
- If unsecured, use our General Buy Direction Letter
- If secured, which form you use depends on the type of collateral securing the note (see our forms for more details)
- The Original Promissory Note with a physical/wet signature and a list of collateral (if the note is secured)
It's important that both documents are complete and accurate, otherwise this can hold up your transaction or cause trouble down the line.
IRA Resources does not provide or assist in drafting promissory notes— we cannot legally do this for you. If you need assistance, there are plenty of resources you can find online with a quick search.
Your note agreement should at least include: the amount of the loan, the maturity date, interest rate, when and how payments are made (e.g. monthly, quarterly, or lump sum), what happens if a note is late (are there late fees?) or isn’t paid back, if it can be transferred to another person, and if any collateral is being offered.
When reviewing your investment paperwork, we're looking for a few things:
- We need all the information on the Buy Direction Letter and in your promissory note to match— this is the most common issue that slows down transactions
- Verify that the dollar amount and borrower's name are correct
- Make sure you have physically signed the promissory note “Read & and Approved” wherever a signature is required
- Clarify you are not investing with a disqualified person or engaging in a prohibited transaction
- Check that the lender is correctly listed as the IRA (IRAR FBO John Doe 35-XXXXX) in all official documents
If any issues come up along the way, an IRA Resources representative will reach out to you to clarify the details and what is needed. Please note, there is a 2 - 3 day processing timeline, so take this into account when submitting your paperwork.
Once your account has been opened, your funds have arrived, and your paperwork has been reviewed, we'll go ahead and send the funds to the borrower (as instructed on your forms). That's it, you've invested in a promissory note with your self directed IRA!
At IRA Resources, you'll pay a $50 transaction fee, plus a charge depending on how you want the funds delivered to the borrower ($7 for a check, $30 for a wire, no fee for an ACH). There may be additional fees if you are using a loan processor or another service to draft your note paperwork, but (if written into your agreement) you can pass these along to the borrower. If you’d like more information, our fee schedule has a more comprehensive breakdown of how we charge.
There are a few things to keep in mind after you've invested, to make sure all goes smoothly with your self directed retirement account. Make sure your borrowers have the right address to send payments and be sure to monitor these payments for accuracy. IRA Resources is not a loan servicer— it is up to you to ensure complete payments are being made in a timely manner and that the value of the loan is accurately reflected on your account.
Ready To Get Started?
Now you know how to start investing in promissory notes (secured or unsecured) with your self directed IRA! The process isn't complicated, you just need to make sure you've covered all your bases.
With self directed IRAs, you've got freedom to invest hardly found in the retirement space— now take that freedom and use it to build your dream retirement. If you have any questions or want to talk strategy, an IRAR Representative would be happy to help.