If you're investing for cash flow or passive income, do you know about private lending?
Private lending is a niche area of finance where individuals or small businesses loan money to others. In short, this niche exists because private lenders can help borrowers bypass the complexity of highly regulated banks.
Borrowers often use private money loans for business purpose, residential renovation or new construction projects. These are short-term loans (generally secured by the real estate) where the private lender charges a higher interest rate than a traditional bank. For instance, a private lender might charge a 10-12% interest rate for a loan to fix-and-flip a house, while a bank might charge a 6-7% interest rate for the same loan.
So, why would any borrower be willing to pay the higher rates? The higher rates that a borrower pays to a private lender are a trade-off for:
- speed: private lenders can close a loan in as little as 5 days vs. the typical 30-45 days for banks
- smaller down-payment requirements: a private lender typically requires a 10% down payment vs. a 20-25% down payments for a bank
- efficiency: a private lender can do repeat loans for a borrower with very little paperwork
For investors, private lending can be an attractive alternative to traditional income-producing investments. Because private lenders typically charge 10-12% interest, plus origination fees of 2%, an investor in this category can achieve high single-digit or double-digit annual returns. Comparing the current income yields from bonds, stocks, and CDs you can easily see why this can be such an attractive option for income investors.
- 2-year CD Yield: 2.59%
- Bond Index Yield: 2.46%
- Stock Index Yield: 1.90%
- High Yield Bonds: 5.16%
- Private Loans: 8-12%
Investors who are interested in this niche have several options. First, you can take a more active approach by lending directly to individuals on an individual property basis. However, this requires you to have the lending experience, the borrowers, the loan documents, etc. Second, there are online peer-to-peer lending websites such as Peer Street or Lending Home. These are loan marketplaces that allow accredited investors to pick and choose loans, one-by-one. Finally, there are private loan funds that offer accredited investors a more passive approach and the diversification of a portfolio of loans. Our own fund Avondale Private Lending is in this category of private loan funds.