Are you interested in real estate investing in a self-directed IRA? If so, one investment you should consider is trust deed investing, which essentially allows you to invest in a loan that’s backed by real estate. 

The following is a guide on trust deed investing, including its advantages and disadvantages. 

What is Trust Deed Investing?

To understand what trust deed investing is, you should first know what a deed of trust is. 

This is a type of document that’s sometimes used as part of real estate transactions throughout the U.S. When someone obtains a loan from another entity to purchase a piece of property, a document known as a deed of trust can be created. 

This outlines the agreement terms and states that the property will be held directly in a trust that’s managed by an independent and neutral third party. The property will remain in the trust until the loan is paid off. 

While mortgages are used instead of deeds of trust throughout most states, 20 states currently mandate that deeds of trust be used. According to state law, the third party that holds the deed of trust can be a bank, title company, or escrow company. Remember that a trust deed and a deed of trust are the same things. 

When you invest in tax liens, earnings come from the interest applied to the lien

If you’re interested in trust deed investing, you will be tasked with making investments in loans that have been secured by real estate. Keep in mind that these are relatively short-term loans that will typically reach maturity in less than five years. 

Many of these investments reach maturity in 2-3 years. Even though your investment isn’t liquid, the fact that it’s not a long-term investment should mitigate this issue somewhat. When lending your money to a borrower, this process can be handled by a real estate broker. 

Because of the current strength of the real estate market, many real estate investors purchase properties that have gone through the foreclosure process or are listed at low prices. They will then fix up these properties and sell them for a high profit. However, banks and other mortgage lenders have always been very reluctant to lend money for short-term loans like these. Their reluctance allows you to step in as an investor. 

You’ll also discover that this investment opportunity is available when a developer wants to begin work on a standard real estate project. 

Your name will go on the trust deed as the primary lender. Once the project has been completed, the loan’s principal will be returned to you in full. In the meantime, your returns will be made available from the interest rate that you’ve charged. 

Since most banks won’t provide real estate investors and developers with this type of loan, you can charge a higher interest rate because of the risk you’re taking on.

Advantages of Investing in Trust Deeds

There are numerous advantages associated with investing in trust deeds, the primary of which include:

  • Access to high-yield income stream
  • Allows you to effectively diversify your portfolio
  • Although investment is short-term, the returns are consistent, and the risk is relatively low
  • Your loan is secured by real estate

Disadvantages of Investing in Trust Deeds

Despite the many advantages of investing in trust deeds, there are also several disadvantages that you should take into account. These issues include:

  • Investing isn’t liquid, which means that you can’t easily access your assets
  • You won’t benefit from capital appreciation
  • You may need to manage the property during a non-judicial foreclosure

Are Trust Deeds Safe?

If you want to operate as a trust deed investor, this form of investment is considered to be relatively safe, which means that it can help balance any riskier investment in your portfolio. 

Your returns will be consistent and are based on the interest rate that you assigned to the loan. Since your loan is backed up by real property, you can be confident that you have some assets that you can claim if the borrower doesn’t repay the loan on time. 

Like any investment, however, there are some risks that you will want to properly navigate. The main risk associated with this investment involves the possibility that the borrower will default on the loan. In this situation, you will need to proceed with foreclosure. 

During the foreclosure process, you will likely be responsible for managing the property until it has been sold, which can take time and money. 

While this risk exists, it’s important to understand that lenders who have invested in trust deeds can proceed with a non-judicial foreclosure, which means that the foreclosure can bypass the entire court system. 

Foreclosure is necessary if you want to obtain the title to the property before selling it off. Because a non-judicial foreclosure bypasses the court system, it’s considerably quicker and more affordable when compared to the alternative. 

Trust deed investing is a relatively safe and reliable form of investing that allows you to obtain consistent returns for an investment that’s backed by real estate. 

Before you engage in this type of investing, make sure that you do your research on potential borrowers, which includes due diligence on the property and the borrower’s financial situation. 

If you take the right approach, your investments can pay dividends and help you build a strong portfolio.