Q: With savings interest rates at practically zero percent, I have been looking at the idea of Trust Deed Investing. I have located multiple Brokers and direct lending opportunities, which would pay 7%-8% and is secured by a house in Sacramento. If I invest through my IRA, the interest is tax deferred. With the real estate market having bottomed out in Sacramento, I feel good about the security behind this type of loan.
Do you feel this is a good investment vehicle to consider in these times?
Brent - Folsom
A: Trust Deed investing has been around for years. Even better is the tangible nature of these investments. Being able to drive past your investments generally resonates.
Essentially, a trust deed allows an investor to become the mortgage bank. The borrow pays either you directly, a third party servicer or a real estate firm the payment agreed in their note or security agreement. The underlying investor, net of origination fees, is then able to receive monthly interest payments.
Trust deeds are private transactions, with a heavily under-regulated structure. Typically, firms that sell these instruments are regulated through the Department of Corporations or Real Estate, which can't insure investors from fraud or breach of contract. Conversely, investments made with your brokerage firm allow the use of the Securities Investor Protection Corporation (SIPC) http://www.sipc.org/
Good investment practice is to take a risk-adjusted return position when investing. If a trust deed paid you 7%, are there other investments with similar yields and lower risk? As you mentioned, savings account interest rates are near zero, most accounts however are FDIC insured allowing your principle the value of guarantee. With a trust deed, you may lose your entire investment by a borrower simply deciding not to pay you. In which case, the cost and timely delay of foreclosure generally reduces large portions of available equity.
Trust deed investors should ask themselves why a borrower is accepting a loan at 7-8% when banks are lending at the near record lows of 3.5%.
As with any investment, proper due diligence is the key to good decision making. Here is a great resource regarding trust deed and mortgage investing, offered by the California Department of Real Estate: http://www.dre.ca.gov/files/pdf/re35.pdf