Using the 3 Cs When Investing in Promissory Notes
As a promissory note lender, you take on the same risks as a traditional financial institution when lending financial support. For this reason, it’s important that you, through your self-directed IRA, use good lending practices by using the three Cs when investing in promissory notes. What are they and why do they matter? Keep reading to find out, then contact the team at iPlanGroup to find out how you can invest in promissory notes with your self-directed IRA.
What are the three Cs?
The three Cs are the factors to consider when deciding on whether you should invest in a specific promissory note with your self-directed IRA. While these can differ slightly depending on your source, the three Cs that we recommend examining for risk mitigation are capital, capacity, and character.
Capital and collateral jointly form the first C. In general, they tell the lender how confident the borrower is in the specific investment based on what the borrower is personally willing to risk to take on the loan. Capital refers to a financial investment made by the borrower, usually in the form of a down payment. Collateral includes any property the borrower is willing to give up in the event that they default on the loan.
Capacity is the second C. This is the borrower’s ability to repay the loan in full. This can take into account the borrower’s income sources, amount of income, and cash flow history. Capacity tells the lender the level of risk the borrower presents and how likely they are to default on the loan. Check out our piece on Loan to Value Ratio to find out how you can mitigate risk in promissory note investments.
Character is likely the single biggest C. In determining whether to invest in a promissory note, there are a lot of financial factors, but there’s only one that requires a gut check. Character refers to the trustworthiness of a borrower and takes into account credit history, experience, reliability, and personal references. A character evaluation will give an investor a bird’s eye view of the borrower and can help to decide whether the investment is a worthy option or not.
Learn More about Promissory Note Investments
Using the three Cs to determine the viability of a specific promissory note investment is a wise way to mitigate risk. However, the three Cs don’t take into account external factors that might affect the borrower’s ability to repay the loan, such as a lost job, an economic crash, or other unforeseen circumstances. For this reason, it’s important to understand What Happens if a Borrower Defaults on a Promissory Note.
If investing in promissory notes is part of your overall investment strategy, contact the team at iPlanGroup to find out how you can use your self-directed IRA to do so. We’ll walk you through the process and help you plan for your financial future. Ready to get started? Schedule your FREE Strategy Session below.