Private Lending Explained: Process, Advantages, and Becoming a Lender/Borrower

Whether you want to get an opportunity funded or are looking to expand your portfolio, private money lending is a win-win for both borrowers and lenders. You’ve probably heard the term thrown around before, but familiarizing yourself with the details of private lending and what you need to know going in can help lead to financial success for both you and the other parties involved.

As a lender, funding private projects is more than just loaning out your money – it’s a portfolio diversifier. Becoming a lender for various opportunities allows investors to dip their toes into new industries without carrying as much risk. Similarly, borrowers love private lending because of its flexibility as compared to traditional financial institutions.

But all great investors know they need to do their due diligence on their opportunities before committing to them, which is why we’ve put together this guide to answer all of your questions on private lending and how you can get started with it.

What is Private Money Lending?

Private money lending, or just private lending, is when private citizens use their personal wealth in order to fund businesses or other projects. This serves as an alternative to borrowing from banks or other traditional financial institutions while allowing lenders to earn a profit in the process. Private lending is most commonly used to buy real estate, although it’s not limited to just that one category. Private money lending could also be used to fund new businesses or personal loans. Although they’re still somewhat regulated, borrowing from a private citizen means the opportunities – and terms of the loan – are extremely flexible.

How Do Private Money Loans Work?

Private lending works similarly to traditional lending. A borrower will make their case as to why they’re deserving of a loan – what they’ll be spending the money on, why it’s a good investment, and how reliable they are to pay it back. This is obviously a bit easier if the loan is being made between family or friends, but private loans are established between strangers every day.

Once both parties agree on the terms and the paperwork is filed, the loan can be dispersed and payments can begin. Private lenders will begin collecting payments plus interest – which is typically at a higher rate than what a bank would charge – in order to turn a profit and make their investment worthwhile.

5 Advantages of Private Lending

Although every asset class comes with its pros and cons, there are a few advantages of private lending that both lenders and borrowers should keep in mind when determining whether or not this strategy is right for your financial goals.

Less Risk for Investors

There is always going to be some level of risk involved in profitable ventures, and private lending is no different. However, becoming a private lender can be less risky than owning real estate or new businesses outright. And because loans are structured as such, lenders can predict exactly what they’ll earn over a period of time. Adding this new asset class also helps to keep investors’ portfolios diversified, which is a strong strategy for mitigating risk.

Low Correlation With the Rest of the Market

Depending on what the loan is being used to fund, private loans typically don’t have much correlation with the rest of the market. So instead of riding the rollercoaster of sudden surges and crashes in typical stocks, lenders can continue to expect monthly payments based on the terms of the loans. Although there are cases where borrowers fail to make payments, it’s much less common than the typical ups and downs of other investments.

Get Projects Funded That Banks Would Typically Pass On

Banks are historically pretty picky about who they loan money to, often leaving small businesses or certain types of real estate projects without funding. But when money is lended peer-to-peer, private lenders can determine which projects are right for them without all of the strict requirements typically set by large financial institutions. If the project seems like a good opportunity – and is being spearheaded by someone with a good track record – there’s nothing stopping private lenders from loaning out the funds the borrower needs to move ahead.

Flexible Loan Structure

Unlike traditional loans, funding from private lenders doesn’t take a one-size-fits-all approach. Payments and other terms can be structured in whatever way satisfies both parties and can adapt as circumstances change. In short, as long as both parties agree, those terms can be whatever makes sense in each situation.

Faster Loan Approval and Funding

Banks and other large financial institutions have set processes and a lot of red tape to go along with those processes. That means that borrowers could wait weeks or even months to get their loan application approved and even longer to receive funding. With private lending, however, lenders will base their decisions on a few concrete factors, and applications can be approved and funded very quickly once that decision has been made.

How to Become a Private Money Lender

Anyone with enough liquid wealth can become a private money lender, but there are a few things to keep in mind before funding your first project. Sure, there aren’t any hard and fast rules about what you can and cannot invest in, but you’ll still want to consider the types of projects you fund.

Be sure to do your due diligence on potential borrowers and the opportunity your money will go towards. Having a good understanding of the industry you’ll be investing in and the team that will be in charge of the funds can help set you up for success. It’s also a good idea to start small and local – smaller projects minimize the risk you’re undertaking in the beginning, and working locally allows you to have a face-to-face relationship with your borrower. Furthermore, make sure you have a good lawyer to help ensure all of the proper paperwork is in place.

Another thing to keep in mind is the regulations in place for private money lenders. If you’re consistently providing loans, you may eventually need to acquire a license. Check your state’s requirements on the necessity of banking licenses to ensure you’re complying with all government regulations.

How to Take Out Private Money Loans

If you have a project or opportunity that would be a good fit for private money loans, finding a lender can be fairly simple. But before you can get approval and funding, you’ll want to have a rock-solid pitch as to why lenders should invest in you and your project.

When seeking out a loan, potential lenders will want an overview of your background, past successes, previous loans you’ve taken out (and successfully repaid), and what exactly this new opportunity consists of. Focus on your strengths while staying transparent – after all, if you’re hiding anything, any lender who knows what they’re doing will likely find out anyway during their own due diligence process.

Once you’ve proven yourself, you may have a few different private lenders interested. Pay close attention to the details of each offer and select the one that makes the most sense for your situation. Also keep in mind that if this project goes well, this could be just the beginning of an ongoing relationship with your private lender.

Get Started with Private Lending

Although many private loans are conducted between friends or family members, it’s not a requirement to know the person from whom you’re borrowing. However, borrowers and lenders alike should be sure that the other party is trustworthy and legitimate before signing on the dotted line.

OpenAlt can help connect potential borrowers with lenders and vice versa. Explore the existing marketplace for investment opportunities or list your own project for investors to consider becoming a part of. Schedule your free demo today to get started.