What if you have saved a bit, and you want to loan some money out for a decent return? Loaning it to your bank (that’s what you do when you put it there) is not one of the better ways.
You are loaning to get a 20% annual return, now that’s more like it. How do you do that?
There are actually several ways. Given the nature of this website, we will look at some of the less common ways to do this.
You may have heard about the organizations which do micro-loans in developing countries to help people start or expand their small businesses.
These loans are sometimes for as little as $100, which can, for example, buy a used bicycle that doubles the number of vegetables a vendor can bring to market.
What is not common knowledge is that the interest charged on these loans is often at a 15% annual rate or higher. This is to cover transaction costs; there is still paperwork to do for even a $100 loan, after all.
If you want to do something similar in this country, you might try going to flea markets, where there are always cash-strapped vendors.
Ask around, and see if any of them need $500 or $1,000 to try stocking a new item for sale, or to buy better display racks, or for anything that might increase their sales.
You can probably charge 2% per month on loans like these. This is an untested idea, by the way, and perhaps the riskiest way to loan money covered here.
On the other hand, you could take car titles and other things as collateral to make it safer.
You can loan money to complete strangers through “social lending” websites and make the interest of up to 20% or more.
The advantage of these systems is that the company which runs the site does the credit check for you and handles collection.
Another significant advantage is that you can buy just a part of many loans, to spread the risk around. For example, on a loan of $6,000, you can contribute as little as $25.
Do that on 40 different well-vetted prospects, and you will have loaned out $1,000 with little chance you will lose much through defaults.
One of the social lending sites, which is well-established, is LendingClub.com.
Buy for Others Using Credit Cards
I knew a woman who used to buy things for her friends using her credit cards. They would pay her back when they got their next paycheck or welfare check.
Now, if she paid her card balance off every month, there would not have been any interest charges. In the meantime, she could have asked her friends for a 5% “purchase fee” for each transaction.
It mainly would have been a loan with 5% interest for the week or month before it was paid. And the money lent was the credit card companies!
If you try this, be sure you have friends you can trust. Are you taking advantage of them? That depends.
If a needed kitchen table is on sale for 20% off, your friend might be better off to get it now and pay you 5% extra when he pays you in a week.
Since the money you lend is really that of the credit card company, there isn’t even a way to figure a return on loan like this.
Playing Mortgage Banker
There have been times recently when banks are not loaning easily on a property that people already own, even if they own it free and clear.
Banks have their formulas and regulations that prevent them from being useful as they once were. As a result, private lenders are filling the gap, but at relatively high-interest rates.
If you want to try this, the rate you charge is up to you (within the law). It may be worth it to someone to pay 20% interest if he only needs the money for a year or less, or if he can make an even better return using the money borrowed.
You can offer, and they can say yes or no.
One investor who does this has two rules he goes by when making these loans, and they seem like good ones to me.
The first is to always be in “first place,” meaning you have the first mortgage on the property, so you recover what is owed from it before anyone else has a claim.
The second rule is to loan no more than 60% of the value of the property mortgaged.
That keeps you relatively safe (but have an attorney review at least the first deal or two you make).
So if a man wants to borrow to expand his business, and his home is owned free and clear and is worth $80,000, you would loan him no more than $48,000.
You can choose to have a fully amortized loan with regular monthly payments for many years, or one with a balloon payment due at some point.
You might loan them money and charge nothing monthly, with the whole amount due with interest in a year.
You could charge just interest every month, with the whole balance due at some deadline. You can make whatever arrangement that works for both of you.
You might want to use an appraiser the first few times you loan money as you learn how to put a value on real estate.
Keep in mind that even appraisers are just guessing at what a property will sell for, so it’s worth learning how to judge market values yourself.
Look at properties with “for sale” signs on them, research enough to guess at the value, and then see what the asking price is–but check back to see what they actually sell for.
This is good practice for judging value, and your guesses should get better in time.
What About Ethics?
Many readers will feel uncomfortable charging high rates of interest when they loan money. This is in part because people are not always sure about the ethics of doing so.
Let’s look at this for a moment.
Is it unethical to charge high interest? Are you unfairly taking advantage of someone when you do so?
You will have to decide that for yourself on a case-by-case basis.
But in my thinking, the purpose of the loan and the likelihood of it fulfilling that purpose are more important ethically, than the rate of interest.
In other words, even at 6% annually interest, I wouldn’t want to loan money for a man to buy drugs or even to buy a television he truly can’t afford.
On the other hand, if I loan a friend $3,000 to buy a car he can fix and sell for $6,000, and I charge him $300 in interest for two months (that’s a rate of 60% annually), I think we would both be okay with that.
You may not always know that your loan will actually change someone’s life.
Still, you can often see with some certainty that to loan money to this or that person will only make matters worse for them.
Avoid the latter types of lending, and you are probably okay, ethically.
Other Ways to Loan Money
Here are a few other ways you can make money lending money.
- Be a Pawn Broker – You can start informally by lending money to people you know while holding televisions and jewelry as collateral. Lend no more than 50% of what you think you can sell the collateral for.
- Be a Hard Money Lender – These lenders provide loans to real estate investors, taking back a mortgage on the properties bought with the money. You can charge up-front fees of 5% and high interest, usually for loans on fixer-uppers that will be renovated and sold within months.
- Loan to Friends and Family – This works well if you have the kind of friends and family that are business-oriented and trustworthy. In my mind, there is nothing unethical about making a profit lending to a brother or daughter if he or she can use the loan in some productive way.