Investing in Distressed Mortgage Notes with a Self-Directed IRA

Published on July 1, 2021

We all remember the Great Recession, the housing market crash, and what that wrought for homeowners who could not afford to pay their mortgages. With COVID-19 bringing unemployment and financial hardship to many families, those with mortgages may be struggling to keep up with their payments. These distressed mortgages—also referred to as nonperforming mortgages—can be invested in through a self-directed IRA and create a win-win scenario for both investor and homeowner.

Distressed mortgage notes, like other private lending transactions, are among the alternative assets allowed in a self-directed retirement plan. These nonperforming mortgages are purchased at a discount—typically anywhere from 10 to 50 percent lower than the property’s value—with repayment terms negotiated by the retirement plan owner and the homeowner. This enables the homeowner—who is likely at risk of foreclosure and losing his/her home—to stay in the home and make payments to the self-directed IRA that now holds the note.

Meanwhile, the IRA generates passive income as the full value of the note is repaid, along with the interest agreed upon by both parties. Plus, the investor builds a more diverse retirement portfolio and a hedge against stock market volatility by including private alternate assets in the IRA.

Example of a distressed mortgage note investment:

• John and Lisa owe $250,000 on their home and their mortgage has an interest rate of 3%. However, John lost his job last year due to the pandemic and Lisa’s salary doesn’t cover all household expenses.
• They are unable to make their mortgage payments and are in danger of foreclosure.
• Sandra has a self-directed IRA and picks up that mortgage for $212,500 (a 15% discount) from the lender that is off-loading a “toxic” loan.
• Sandra works out new payment terms with John and Lisa for the full $250,000 mortgage amount but at a lower interest rate, for a longer term to spread out their payments.
• Sandra’s self-directed IRA makes the extra $37,5000 on that loan amount plus interest.
• John and Lisa get to stay in their home while they work out their finances.

Due diligence on distressed mortgages

Self-directed investors are accustomed to doing due diligence on their potential investments, and distressed mortgages should be no exception. Like any investment, these notes can carry risks, especially since the buyer (the self-directed IRA) becomes the creditor.

For example, what if the homeowner defaults? The self-directed investor would be wise to research foreclosure laws in that state to ensure they have a backup plan. In addition:

• Although the loan is secured by the real estate as collateral, it’s critical to know the property’s current value by hiring a professional appraiser.
• Know the original loan terms – it sounds elementary but be sure to have the interest rate, timeline, and amount borrowed documented so you can evaluate the value of the investment opportunity.
• Vet the borrower’s credit history and ability to repay the loan.
• Consult a trusted advisor about any tax liabilities the investment may incur.

If the investor decides not to work with the homeowners, the self-directed IRA can resell the property or retain it as a rental investment. Again, as with any self-directed investment, it is the responsibility of the account holder to ensure due diligence, full transparency, and a clear understanding of all tax and legal ramifications.

Where to find nonperforming mortgages for investment

Although lenders will typically sell these notes to get them off their books, there are also online marketplaces and trading platforms that sell notes. However, expect to pay more for these notes than buying direct, as these are retail resellers.  You can also invest in a company that buys nonperforming mortgages from banks at steep discounts.

At Next Generation, many of our clients include real estate as well as secured and unsecured loans within their self-directed retirement portfolios. Adding distressed mortgage debt is another valuable way to build retirement savings through alternative assets—with the potential of helping homeowners stay in their homes. If you have questions about this or other alternative assets allowed through self-direction, feel free to schedule a complimentary education session with someone from our team. You can also email NewAccounts@NextGenerationTrust.com or call 888.857.8058.