Beginner’s Guide to Becoming a Private Lender
Private credit has accelerated in recent years. This despite the high interest rates charged by private lenders. There are many reasons that have pushed lenders into this space, including the more stringent requirements of banks.
Also, banks tend to shy away from lending money to small businesses and startups. As a result, many borrowers are looking for other means of financing, and such opportunities open up opportunities for private lenders.
However, getting started as a private lender is not an easy walk in the park. There are many risks lurking in the business, and you must act with caution. In this article, you will 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 a private loan?
Before we get into how to become a private money lender, it is important to understand what you are getting yourself 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 traditional loan items, although the rules may be different.
Many people opt for these loans for a number of reasons such as financing personal loans, home loans, and business loans. The latter case is quite common as it is nearly impossible for a small business or startup to get a loan from a bank.
Tips for becoming a private lender
Calculate the risks before taking them
Risk-taking is common in business. However, it is absurd for you to make an investment without doing the math, so you will understand the risks. The private loan involves what is called “parking” money. It’s more like passive investments in huge projects like shopping 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 necessary expenses in the event of default by the borrower and you need to go to court to get your money back. Otherwise, you could end up with serious debt that can hurt your creditworthiness.
Seek out financial experts who can add to your knowledge to make you a smart lender.
Know everything about the investment you intend to finance
To be successful as a private lender, you need to understand the investment that is presented to you. You will also need knowledge in this particular industry. For example, if someone wanted a loan from you to invest in the tech industry, if you don’t have any knowledge in this area, you wouldn’t know what questions to ask.
It doesn’t mean you can’t invest. However, you will need expert advice from industry veterans 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 will need some tough nerves
Nerves of steel will come in handy in this endeavor because the money doesn’t always arrive on time. You need to prepare for such scenarios. To ease these frustrating times ahead of time, it helps to gain in-depth knowledge about the particular project. This way, you will have expertise that could help speed up the project.
Get the best team you can
Some borrowers can be difficult to deal with, and as a private lender you need to counter this. One way is to hire skilled employees in all aspects of your business to handle different angles like paperwork and collections.
By putting your documents in order, you can challenge the borrower in court. In court, you also need a strong legal team to represent you.
Besides lawyers, you need a knowledgeable accountant to help you analyze tax details, the financial aspect of various transactions, and provide you with monetary advice.
Is the project worth it?
This is a question you should ask yourself before entering into private transactions. Besides the rate of return on your investment, you need to look at the investment in terms of the work involved, as well as the risk.
The interest might be good, but is it worth it if you are only investing a small amount? This is where the tough questions come in, and critical decisions are needed to make a smart investment.
Some lenders end up securing company assets when borrowers are in default. To avoid such scenarios, as a lender you need to understand the business. In this way, you improve the cash flow of the business, thus improving it as a whole, resulting in a win-win deal.
Always check the numbers
As a private lender, you are likely to come across questionable offers from fraudulent people. However, to stay afloat, you have to look at the numbers yourself. Sometimes the deal is just too good to be true.
Many times your potential borrower is incompetent when it comes to bookkeeping, which isn’t much different from fraud. It’s important to always take the time to make sure the numbers add up.
Measures to be taken in the event of borrower default
Borrowers could at default times on payments, and lenders should be prepared for such periods. One way to go about this is to initiate a foreclosure to claim the collateral offered by the borrower to secure the loan. Note that this is an intensive process, both in terms of finance and expertise.
This is where your legal team comes in to guide you through the process.
You have the capital, but where to start?
You may have the capital, but how do you get borrowers? The best way is to join a peer-to-peer lending platform. Some of the most renowned platforms are Lending Club and Prosper.
The two platforms bring together investors and borrowers, and for this reason, lenders have a wide range of options to invest in. Although the rates of return on these platforms are in the double digits, they are still better than those offered by banks.
The pros and cons of becoming a private lender:
Like any other business, private lending has its own advantages and disadvantages.
- The obvious advantage of the private loan is the return it implies. As a private lender, you can expect to get around a 15% return on investment. This is a fairly high return compared to bank investments or bonds.
- If the borrower defaults, the lender can step in to secure the collateral through foreclosure.
- As a private lender, you can avoid the headaches of renting and flipping over by investing in real estate.
- Since the private loan takes a short time on average, the investor can move in and out of the money as they see fit.
- The private loan is quite secure since you can hold the assets of the borrower as collateral for the money loaned.
- Private loans are not accompanied by favorable taxes compared to an asset held.
- As lucrative private loans are, their growth is not similar to that of an asset you own.
- Lending for the long term can lead to losses caused by inflation.
- This industry also lacks standardization, which means there is a good chance that the borrower will default.
While private loans produce lucrative returns, it’s important to note that they come with their own share of risks, some of which have been listed and explained in this article.
As a private or aspiring lender for that matter, you can use these tips as a cheat sheet to grow your business.