While most people are familiar with many standard self-directed IRA real estate investments, did you know you could also invest in other financial instruments, such as tax liens, mortgage notes, and trust deeds? 

Trust deed investing is one of the many perks of signing up for a self-directed IRA. Under this strategy, investors can purchase a deed of trust holding real property during a real estate agreement and collect money on the loan until it is paid off.  

The following guide on trust deed investing, including its advantages and disadvantages, can help you decide if this investment path is right for you.

What Is Trust Deed Investing?

When you invest in a deed of trust or trust deed, you’re investing in a real estate agreement, much like a mortgage note. A trust deed functions similarly to a mortgage, setting out the lending terms and conditions between a borrower (property owner) and lender.

Here are some defining characteristics of trust deed investing:

• When you invest in a deed of trust, the borrower will repay the principal balance and the interest specified in the promissory note.
• Loans associated with deed of trust investing are secured by real estate.
• Deed of trust loans are relatively short-term, reaching maturity in less than five years, though often 2 to 3 years.
• A real estate broker typically handles the lending process.

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 these properties and sell them for a high profit. However, banks and other mortgage lenders may be reluctant to lend money for short-term loans like these, so they often turn to trust deeds as a second layer of security.

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

How Do Trust Deeds Work?

Trust deeds represent a real-estate purchase agreement between a lender and a buyer. In some states, like California, North Carolina, and Texas, deeds of trust replace mortgage agreements. In others, like Arizona, Maryland, and Montana, buyers can often choose between the two options.

Each deed of trust has three parties:

• Trustor, or buyer.
• Trustee, or the entity that holds the title to the property.
• The beneficiary, or lender. This can be a financial institution, like a bank, or an individual.

When a property is financed, the borrower gives the beneficiary a promissory note(s), a written document that promises repayment. As with a mortgage, the borrower agrees to repay the loan amount according to the terms and conditions (interest rates, maturity date, etc.) outlined in the deed of trust.

During the repayment period, the trustee holds the legal title to the property. If the borrower repays the loan as indicated in the agreement, the trustee dissolves the trust and gives it to the borrower, who owns the property free and clear.

If the borrower does not adhere to the repayment agreement, the trustee can move to foreclose on the property without judicial intervention.

What’s included in a deed of trust?

Every deed of trust must include the following:

• Original loan amount.
• Repayment terms.
• Inception and maturity dates.
• Names of all parties (trustor, trustee, and beneficiary).
• Any fees included.
• Default terms.
• Any riders, clauses, or other specifications particular to the sale.

Trust Deeds vs. Mortgages

Trust deeds and mortgages are very similar legal agreements that govern a real estate loan.  Both are public records, subject to state laws, and are secured by property. However, there are critical differences between the two.

As explained above, a deed of trust is an agreement that involves three parties: the trustor (borrower), beneficiary (lender), and trustee (legal title holder). A mortgage includes two parties: the borrower and the lender.

The most crucial difference, however, has to do with the foreclosure process.

• Mortgage foreclosures require judicial intervention, which can be a lengthy process.
• Deed trust foreclosures do not require judicial intervention, allowing the trustee to take possession of (and sell)  the property quickly.

Trust Deeds for Foreclosures

Trust deed foreclosures can occur faster (often cheaper) than mortgage foreclosures. Trust deeds include a power of sales clause, which gives the lender the right to sell the property if the borrower defaults. No lawsuits are filed or courts involved, meaning the foreclosure process is limited to a few months, though the exact amount of time varies by state laws.

When a lender forecloses on a mortgaged property, they have to engage with the courts by filing a lawsuit against the property holder. During the process, the borrower can file a response to the foreclosure lawsuit. Depending on the borrower’s defense, the process can be drawn out by a discovery period and other legal engagements. It can take months to years to complete a judicial foreclosure.

Advantages of Trust Deed Investing

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

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

Risks of Trust Deed Investing

Despite the many advantages of investing in trust deeds, there are also several risks 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.

5 Tips for Trust Deed Investing

Trust deeds can present self-directed IRA (SDIRA) owners and other investors with a lucrative and reliable opportunity. If you’re considering investing in a trust deed, keep these five tips in mind:

1. Practice due diligence. As with any SDIRA asset, you should always complete due diligence before investing in a trust deed. Look at the property, evaluate the borrower, and avoid investing in trust deeds that may present a higher chance of foreclosure.

2. Prioritize properties with low loan-to-value (LTV) ratios. Borrowers who can put a higher down payment on a property have more equity from the start and are often more motivated to adhere to their repayment agreement. To reduce risk, look for deeds of trust for properties with low LTV ratios.

3. Look for properties with promising futures. A property’s value can directly impact the risk and your earnings. Properties with a better chance at appreciation or revenue generation over the next few years are preferential to those at risk for depreciation or stagnation.

4. Consider your overall investment goals. Do you want multiple, small deed trusts that allow you to diversify, including by property type and geographic location, or do you prefer a larger investment that may get more interest in a single transaction? It’s also wise to consider the loan term and your ability to liquidate, though most deeds of trust investments are short-term.

5. Work with the experts. It may sound appealing to go alone, but doing so can cost you more in the long run. For instance, working with an experienced trustee can set you up for success, as they’ll match you with investment opportunities with vetted and qualified borrowers. Similarly, a loan servicer can save you from paperwork and manage payments.

Are Trust Deeds Safe?

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

Your returns will be consistent and based on the interest rate 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 navigate properly. 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 the foreclosure can bypass the entire court system.

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

Trust deed investing is a relatively safe and reliable form of investing that allows you to obtain consistent returns for an investment 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.

FAQs

What types of properties are involved in trust deed investments?

You can typically invest in trust deeds for various properties, including residential structures, such as single or multi-family homes, and commercial properties, such as office space, shopping centers, etc. You can also invest in deeds of trust for land.

Remember that each property type has its own benefits and risks, making it vital to evaluate your investment goals and perform due diligence before making a decision.

Can individual investors participate in trust deed investing?

Yes, individual investors can participate in trust deed investments. You can also invest in a trust deed with multiple individuals. For instance, if you’re leveraging SDIRA funds to invest in a trust deed but don’t have enough cash in the account, you can partner with another SDIRA holder to fund the investment.