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 What is a Promissory Note?

A promissory note is a form of debt that may be held in a self-directed IRA. The borrower, through the note, promises to return the IRA owner’s funds, and make fixed-interest payments to the IRA owner in exchange for borrowing the money. Promissory notes have set terms, or repayment periods, ranging from a few months to several years. The self-directed IRA owner or a third party servicing agent will have the responsibility of collecting the principal and interest due on behalf of the self-directed IRA.

Promissory notes are typically marketed to sophisticated investors with the expertise to determine if the investment is appropriate.

There are two types of promissory notes:

  • Secured notes are backed by collateral, providing the lender increased assurance of return of the loan amount and interest, such as mortgages and deeds of trust.
  • Unsecured notes are not backed by collateral. Individuals might consider an unsecured note for perhaps a friend or a non-disqualified relative, but it is a higher risk—and sometimes reward—than a secured note.

Promissory notes may be either in first or subordinate positions and may be purchased from brokers or private parties. When secured by a mortgage or deed of trust, the documentation is typically recorded at county recorder's offices, and the custodian usually requires property insurance.

Retirement accounts may also purchase or sell portions of promissory notes, typically seen with mortgages and deeds of trust. In such cases, the account holds an undivided interest in that portion of the note and receives the proportionate amount of income due under its terms. In addition, retirement accounts may purchase discounted notes as well as real estate purchase options.