Private lending has picked up the pace in recent years. This is despite high-interest rates charged by private lenders. Many reasons have pushed lenders into this space including tightened requirements by banks.
In addition, banks tend to shy away from lending money to small businesses and startups. As a result, many borrowers look for other ways of funding, and such opportunities provide opportunities to private lenders.
However, starting out as a private lender is no easy walk in the park. Numerous risks lurk in the business, and you need to tread with caution. In this article, you’ll learn how to become a private lender and some of the pros and cons involved, so if you have an interest in becoming “a bank,” read on.
What is Private Lending?
Before getting into how to become a private money lender, it is important to understand what you’re getting into. ‘Private money loans’ is a term used to describe loans acquired outside of banks. These loans are offered by organizations like realistic loans or individuals, but they come with elements of traditional lending, even though the rules can be different.
Many people opt for these loans for a number of reasons such as financing personal loans, real estate loans, and business loans. The latter is quite common because it is nearly impossible for a small business or a startup to secure a loan from a bank.
Tips on Becoming a Private Lender
Calculate Risks Before Taking Them
Risk-taking is common in business. However, it is absurd for you to make an investment without making calculations, so you’ll understand the risks. Private lending involves what is known as “parking” money. This is more like passive investments in huge projects like malls and apartments.
Such investments require a lot of capital, and as a private lender, you need to make sure that you can cover the expenses required in case the borrower defaults and you need to go to court to recover your cash. Otherwise, you can end up with serious debts that can damage your credit worthiness.
Seek financial experts, who can add to your knowledge so as to make you a smart lender.
Know Everything You Can about the Investment You Intend to Fund
To succeed as a private lender, you need to understand the investment presented to you. You’ll also need knowledge in that particular industry. For example, if someone wanted a loan from you for investing in the tech industry, if you don’t have knowledge in that field, you won’t know which questions to ask.
This doesn’t mean that you cannot invest. However, you’ll need expert advice from veterans in the industry for clarification and decision-making. In addition to knowing and understanding the investment, you need to see it physically. Therefore, the best advice at this point would be to lend locally.
You’ll Need Tough Nerves
Nerves of steel will come in handy in this business because the money doesn’t always come in on time. You have to prepare for such scenarios. To ease these frustrating times in advance, it helps to gain in-depth knowledge about the particular project. That way, you will have some expertise that might help to accelerate the project.
Get the Best Team Possible
Some borrowers can be difficult to deal with and, as a private lender, you need to counter this. One way is by hiring qualified employees in every aspect of your business to take care of different angles like paperwork and collections.
By getting your documents in order, you can challenge the borrower in a court of law. While in court, you also need a strong legal team to represent you.
Besides lawyers, you need a competent accountant to help you analyze tax details, the money angle in various deals, and provide monetary advice.
Is the Project Worth the Hassle?
This is a question you need to ask yourself before entering into private deals. Apart from the rate of return on your investment, you need to take a look at the investment in terms of the work involved, as well as the risk.
The interest might be sweet, but is it worth the hassle if you’re going to invest only a modest amount? This is where the hard questions come, and critical decisions are needed to make a smart investment.
Some lenders end up securing the assets in the business when borrowers default on payments. To avoid such scenarios, as a lender, you need to understand the business. This way, you improve the cash flow in the business, thereby improving it as a whole, resulting in a win-win deal.
Always Verify the Numbers
As a private lender, chances are that you’ll come across dubious deals from fraudulent people. However, to remain afloat, you need to scrutinize the numbers yourself. Sometimes, the deal is just too good to be and true.
Many times, your prospective borrower is incompetent when it comes to accounting, which is not much different from being a fraud. It’s important to always take time to make sure the numbers add up.
Actions to Take If the Borrower Defaults
Borrowers might at times default on payments, and lenders have to prepare for such times. One way to go about it is by initiating a foreclosure to claim the collateral the borrower offered to secure the loan. Note that this is an intensive process, both in terms of finances and expertise.
This is where the legal team you have comes in to guide you through the entire process.
You Have the Capital, But Where Do You Start?
You might have the capital, but how do you get borrowers? The best way is by joining a peer-to-peer lending platform. Some of the most renown platforms are Lending Club and Prosper.
The two platforms bring investors and the borrowers together and for that reason, lenders have a wide range of options to invest in. While the rates of return in these platforms range in the low double digits, they are still better than what the banks offer.
The Pros and Cons of Becoming a Private Lender:
Just like any other business, private lending comes with its own pros and cons.
- The obvious advantage of private lending is the returns involved. As a private lender, you can expect to get about a 15% return on investment. This is quite a high return compared to bank investments or bonds.
- If the borrower defaults, the lender can move in to secure the collateral through foreclosure.
- As a private lender, you can avoid the headaches of renting and flipping by investing in real estate.
- Since private lending takes a short time on average, the investor can take the money in and out at will.
- Private lending is quite secure since you can hold the borrower’s assets as collateral for the money loaned.
- Private lending doesn’t come with favorable taxes when compared to an owned asset.
- As much as private lending is lucrative, its growth is not similar to an asset you own.
- Lending in the long term can result in losses caused by inflation.
- This sector also lacks standardization, which means that there is a good chance that the borrower will default.
While private lending yields lucrative returns, it is important to note that it comes with its own fair share of risks, some of which have been listed and explained in this article.
As a private lender or an aspiring one for that matter, you can use these tips as a cheat sheet to grow your business.