Remember those movies with the loan sharks who lend people money and then their gang goes to find the poor soul who borrowed money from them? Minus the gang and harsh treatment, this is an actual business that you can build up for yourself. People need money to build and expand business and if you are sitting on money without knowing what to do with it, then you just need to find the people who need your money more than you do. Especially in a rising interest rate environment, you may be able to offer someone a great interest rate that is better than what they can get elsewhere and great for you since you might not be earning much on idle cash at the moment.
What is Private Lending?
This is when you act like a bank and lend money to others. Simple as that. Just like a bank, you loan your funds out to those who meet your qualifications and typically have some collateral (assets) that they are willing to give you if they can’t pay you back. This is generally why business type loans are less risky since there is something at stake to lose.
Personal loans are risky because it is just the borrower’s word you can take on a contract. High interest rates are charged on these to compensate you for the risk you are taking. Obviously if you have a really good relationship with the borrower and know they are good at managing debt then the risk is lower. However, typically to grow your income, you’ll have to branch outside your immediate family and friend group (otherwise you could have some awkward family reunions/dinners).
There are many reasons people need money they don’t have. Maybe they are buying or expanding their own business and need funds to complete some transactions. Those who fix and sell real estate sometimes are very good at what they do, but don’t have the capital to make the initial purchase or renovations. That is where you come in to save the day! Either you can be paid back when the business or real estate is sold while making passive income from the interest payments along the way or you can make them pay you principal and interest to recoup some of your initial investment. You get to choose your terms since it’s your money…or is it?
Some people will actually borrow money to lend it back out! If you don’t have cash but find someone who needs money and is willing to pay 12% interest on it, then you could go to a bank, your rich uncle or friend, etc. and ask for a loan that you will pay at 4% interest on and turn around and lend those funds out to the person willing to pay 12%. You’ll be the “middle-man” making 8%! That might be a better return than your other income streams depending on the economic environment at the time of the loan.
How does this grow my passive income?
Just like a bank, the more quality people you lend money to, the more money you’ll have coming in. This is very similar to investing in bonds. The higher the quantity of bonds or the more you have invested in a bond will increase your passive income. Likewise, the more loans you make or the higher the amount or interest rate you offer will earn you more income. Instead of a business or government making an offering to others, you are offering to others the opportunity to use your money.
You may choose to diversify between personal loans for people to pay off their high-interest credit card debt and real estate loans to help someone flip a property in a short amount of time. Not only does it increase the number of income streams you have but reduces the risk of putting all your funds with one borrower.
Why do I want this passive income stream?
If you have experience in an industry (cryptocurrency, finance, construction, real estate, technology, etc.) you may be privy to others in the industry who are looking for funds in order to complete a project. This gives you an advantage since most other investors are looking for public securities that may not be as lucrative. Your experience will greatly reduce your risk when assessing these off market opportunities.
Even if you end up going with a lending platform that connects you to potential borrowers, you may benefit from a consistent income stream that has been vetted by professionals. As stock and bond portfolio values fluctuate with changes in interest rates and investor sentiment, your loan could give you a consistent return that can smooth out the volatility your other investments may be experiencing.
Risks and Considerations
As with the other BUILD assets, you need to have a team around you that can help you build out your income streams legally and efficiently.
There are lender’s attorneys that can help you craft contracts, often referred to as promissory notes, so that you are protected. Financial planners and tax advisors may be able to help you assess which accounts you should use in order to do business. You may be advised to use a lower-interest loan so that you can have some expenses to offset your income or use funds out of a self-directed IRA so that you don’t have to pay any taxes on the income until you need them for retirement.
All the risks associated with bonds are also present when lending money: the borrower could default and you have to take over their project, interest rates could go down which gives you reinvestment risk and you have to choose between offering lower rates on your loans or taking on riskier borrowers, etc. While the pursuit of passive income is a worthy cause, you must always think about your capacity, financial stability, and skill level. Building passive income is not the easiest route to financial freedom, but it does have the potential to offer you extraordinary returns.