Promissory notes are alternative methods for businesses and individuals to obtain funds if they don’t qualify for a traditional bank loan. They are basically an official and legally binding IOU. The owner of an IRA can use their IRA funds to finance these notes, and they have the authority to set specific terms to the agreement. IRA owners can decide the term length (how long the borrower has to pay them back), the interest rate, the dates for when each repayment is due, and even consequences in the event the borrower fails to meet these requirements.
Promissory notes can help IRA owners diversify their portfolio with a long-term investment. Since promissory notes have high interest rates, IRA owners typically earn high rewards on these investments when they reach maturation. They can also guarantee cash flow for years, as the borrower must make the payments on time.
Like any investment, not all promissory notes are sure investments. If the borrower defaults, especially on an unsecured note, the IRA owner could lose on the investment. It’s important to research the borrower and discuss this option with your broker before investing in promissory notes. Secured notes are safer since they will include collateral, but unsecured notes allow for higher interest rates and returns on the investment. Generally, promissory notes are only an available option through self-directed IRAs, and there are two ways IRA owners can invest in a promissory note.
Promissory Notes for Businesses
When businesses have used all other means for securing funds but still need another option to keep running, they can obtain credit through promissory notes. Some industries are inherently riskier than others, and it is recommended that IRA owners investing in corporate promissory notes have knowledge or experience in the field beforehand to make an informed decision. With corporate promissory notes, the IRA owner can stipulate that the repayment be made with cash or with equity in the company itself. IRA owners can also ask for equity in the company or other business assets if the business defaults on the loan. This can help IRA owners protect their investment, and/or provide options to both the IRA owner and borrower for repayment.
Mortgage Promissory Notes
If a home buyer doesn’t qualify for a traditional bank mortgage loan, they may have the option of purchasing a home directly from the seller through a promissory note. The seller will keep the mortgage and the deed of the home while the buyer makes fixed payments to them while residing in the home. If they default on their payments, the seller, who still has the deed, keeps the home as collateral. However, if the buyer fulfills the terms and continues to pay, they legally own the home. This also ensures continual income with interest for the IRA owner as long as the buyer doesn’t default.
Promissory notes are typically only available through self-directed IRAs, but can help investors diversify their portfolios and guarantee income for the time specified in the agreement. Talk to your financial advisor to see if promissory notes line up with your long-term and retirement goals.