To invest in private lending means that you lend money to people and then collect payments from them until to recover the original amount (the principal) and an additional amount (the interest) which, after deducting any expenses you incurred during the transaction, becomes your profits.
You can loan money to people for a variety of things such as real estate, cars, boats, debt consolidation, home renovation, and more. To succeed in private lending you need to focus on just one or a few of those things to understand it so that you can make good decisions about who to lend money to and how much to lend them and what other terms of the deal should be.
There are two kinds of loans: secured (with collateral) and unsecured (because there’s no collateral). Secured loans are lower-risk because if the borrower doesn’t repay, you can take possession of the collateral. Unsecured loans are higher-risk because if the borrower doesn’t repay, you don’t have any recourse. For this reason, unsecured loans are typically priced higher (in terms of interest rate) than secured loans.
There are two common types of payment plans: mortgage-style principal and interest payments for a fixed term, and interest-only payments for a fixed term followed by a balloon payment of all the principal owed. However, in private lending you can create a custom payment plan that fits the deal and this is a big advantage both for you (to close deals with borrowers) and for your borrower (to borrow from you instead of the bank). For example, one kind of custom payment plan is where the borrower repays the entire amount plus interest on the same day or the next day. This is used when the borrower is trying to close two consecutive transactions with the same property such as buying it low and selling it high and already has both the seller and the buyer lined up, but needs to have the property in their name before selling it so they still need to borrow the full amount to buy it but they’ll have the money to repay that immediately when they do the selling transaction the same day or the next day. In this case you can set an interest rate and payment plan on the loan just in case their second deal falls through and then provide an “early payment” interest amount that would be the amount of interest they would actually pay you if they pay off the loan within 2 days.
To “close” a private lending deal means to execute a lending agreement and fund the loan, at which point you’ve committed the money and the borrower has committed to repaying it. If the loan is secure, the deed or title to any pledged collateral must be provided and (if applicable to the asset type) the lien recorded with the county clerk.
You can invest in private lending by yourself or with a partner or a group of investors. If you’re doing it by yourself, you need to find borrowers, evaluate deals, complete the paperwork with the buyer, collect payments, track balances owed and payments due, send late payment and default notices to borrowers with overdue payments, and foreclose on the pledged collateral if borrowers default on a secured loan. If you’re doing it with a partner, you should both be involved in evaluating the deals but you can divide up the rest of the work. The advantages of working with a partner are the division of labor and also having more money available to lend so you can have more deals or bigger deals. If one partner is doing more work than the other, you might want to consider that the revenue split might not be 50/50 or that they’ll receive an additional fee from every transaction. If investing as part of a group, someone is going to be the lead investor who takes care of most of the work and that person will probably want additional compensation for doing all that, either as a higher percentage or revenue or as an additional fee from every transaction. There’s also additional work to do when investing with a partner or as part of a group, and that is ensuring that everyone has access to all documents and sending the profit payments to all the partners.
If you want to make money with private lending but don’t have enough money to lend out, there’s another way to do it. You can set up the entire deal where you find the borrower and you find the private lenders, you make sure that both sides approve of the deal, you take care of all the paperwork, and you take a fee or commission. After you do this enough times you’ll get good at it, you’ll build a contact list of wealthy people who have money to lend, and eventually you’ll either have enough money to lend yourself or you can make a business of just putting deals together.
When you make a secured loan, you need to consider the loan-to-value ratio (LTV). This ratio is simply the amount you will lend out divided by the amount the pledged collateral is worth. If it’s 100%, that means you’re lending out the entire amount that the asset is worth. That’s a risk to you because if the borrower defaults on the loan and you have to foreclose on the asset, if it decreased in value during that time that’s money you can’t recover. If the LTV is higher than 100%, that’s even worse because it means you’re lending out more money than the pledge collateral is even worth at the time. Also, your losses are more than just the principal because you’ll have legal fees related to the foreclosure. For this reason, the LTV should be less than 100%. The LTV is the lender’s perspective of the down payment. When you want a mortgage from the bank and they tell you that you need to put 20% down, that’s the bank saying they want their LTV to be 80% on that deal.
When you make a secure loan, you need to be aware of any other lenders who may already have an interest in the same collateral. In real estate, you can check by getting the property records from the county recorder and looking for other liens. You will also need a statement from the borrower affirming that there are no other interests in the property. In vehicles, you get the title document from the borrower and you fill out the lender’s portion. If anyone else did that, the borrower wouldn’t be able to give you the title.
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