There may be times when you have enough money sitting pretty in your bank account providing you with nothing but a minimal interest in return when you will look for ways to invest it to get high returns. If you are looking for really high yields then lending your money to people in need can be a far too feasible approach than investing in stocks, bonds and shares. Though both have risks of its own, the level of risk in money lending seems to be far too less as compared with other traditional investment options.
Lending money is a flourishing business now, thanks to the booming real estate industry which seems to be undeterred even by economic downturns. However, you will need to be a bit cautious in your approach though the returns are high. This is due to the fact that there is a flood of deals available which as a result has caused the credit standards to slip.
Lending money is also the safest and most popular way of making money just as it was in the olden days. However, as the private money lenders do not run a bank but merely function as a business development companies, firms need to be more careful about lending money in order to make the most out of the booming trade of private funding.
Functions and areas covered
The rise in private money lending business was seen to rise steeply in the 1990s, though it was prevalent even prior to that. There are few characteristic features of these private money lenders such as Liberty Lending USA and can be enlisted as follows:
- These private money lenders work in the capacity which is much similar to the Real Estate Investment Trusts or REITs or the closed-end mutual funds.
- They lenders usually trade as stocksbut each one of these is essentially an assortment of investments which is ideally in the form of loans to companies.
- Of late, there has been a significant rise in the number of such private lenders is noticed all because of the growing interest and appetite of the investors in private money lending.
- According to reports and different studies, about 90% of all these money lenders have a combined share of more than $97 billion of the money market which is more than double of their assets five years ago.
The pitch for private money lending and debt taken out by borrowers is however simple and their rate of success is also a result of the lending and operational policies of the traditional banks that have been pulling back on loans of late. With the likes of pension funds, hedge funds, endowments, and the others having a plenty of money in their hand to play with, investors can lend money to businesses now more easily and directly.
Reasons for success
The reasons for the stupendous success of private money lending and the scope of earning high yield depend on a few specific factors. These are:
- Everyday investors are attracted to BDC stocks because they pay rich dividends. This is because the interests collected on the loans are distributed.
- The borrowers are chiefly those small and midsize companies that are most likely not to be eligible to borrow from traditional banks.
- Over the years it is seen that the average dividend these Business Development Company stock index paid was about 10 percent or even more making these the highest yielding as compared to the insignificantly low yield of about 3 percent on any typical bond fund.
However, it is also seen that the seismographs of these BDC stocks registered faraway tremors as typically these are predominantly sensitive to the reverberations in US corporate credit. It is for this reasons that experts and even longtime private debt practitioners practically warn people regarding the underwriting standards in general that may weaken due to more money flowing in like flood water and more loans are made.
Be cautious to eliminate risks
Just as any business even money lending has its own inherent risks as well. However, these risks are not hard to overcome provided you are a bit cautious in your approach. You must sense the trouble ahead and work towards eliminating it.
Often it is seen that there are significant risks that lurks behind the enticing yield of the BDC stocks. When such companies are taken to public there is a chance that the share price may plummet by as much as 70 percent. This collapse can however be cushioned to some extent for the investors in the form of dividend payments. That means, the investors do not have to worry about losing all their money but still may lose a fair chunk of it.
Therefore, one apparent misstep in loaning may result in a loss and scaling back. Therefore, never be in a hurry to make a loan with the money you have. Remember, you will have to run off the road the traditional banks follow which is where the risks lie in private money lending. However, the fact that you will be liberal in loaning money to borrowers who will find it difficult to attain form a traditional bank will enable you to charge high fees and thereby high yields.
Risky loans have all the chances to go bad and therefore you will need to make bigger loans to higher quality companies and persons to cushion such risks of bad debts and write offs.
Paving the path
With the economy expanding it is easier for companies and individuals to lend money and to make loan payments, as the case may be. If you look at the economy index the total return on the BDC stocks since February 2011 has reached to a significant and promising 6% and is annualized.
What happens from here is what you should look for and be careful of as this is the more significant part of the private money lending and credit puzzle. The point of concern is that more and more people are throwing in more and more money at direct lending.
Marina Thomas is a marketing and communication expert. She also serves as a content developer with many years of experience. She helps clients in long-term wealth plans. She has previously covered an extensive range of topics in her posts, including money saving, Budgeting, business debt consolidation, business and start-ups.