Most of us have borrowed money in the past to buy a car or a home or something else that we did not have enough cash on hand to buy outright. Banks make money by lending money to others and charging interest on the amount loaned.
What if you could be the bank? It’s possible and can be profitable to do so.
Here’s what it takes:
- Have the money to lend.
- Have some tolerance for risk.
- Identify a credit worthy borrower.
- Document the loan.
- Secure the loan.
Having the money
Of course, to lend money you need the available cash in the first place. However, the amounts at issue are not always that large . We have seen private mortgage loans just in the last few weeks ranging from $30,000 to $200,000.
Private loans (just like any loan) have risk attached. The risk can be larger or smaller depending on a number of factors including: the amount of the loan, the credit worthiness of the borrower, the availability of collateral to secure the loan, and the degree to which any collateral is leveraged. On this last point, for example, a $50,000 secured loan for the purchase of a property worth $200,000 is relatively lower risk than a loan equal to the value of property being purchased. Risk is often partly addressed by assigning an appropriate interest rate. Generally speaking, the higher the risk attached, the higher the interest rate you would expect to see. This makes sense. If you are going to take more risk, you want a higher reward.
Credit worthy borrower
When banks or other commercial lenders grant loans, they usually go through an evaluation process to assess the credit-worthiness of the borrower. This is a risk mitigation strategy. The evaluation process may include doing a credit check, reviewing financial status documents, and doing a variety of other searches. Private lenders should do the same due diligence and lawyers can assist with some of that.
Documenting the loan
One of the common mantras for lawyers is “get it in writing.” This is no different for loans. It is critical that loans be properly documented in writing, This is to ensure that the borrower’s obligations are clear and that the terms of the loan are clear. In addition, if the borrower is providing collateral to support the loan, appropriate documentation in writing MUST be in place. Lawyers can add considerable value in preparing loan documentation for you.
Securing the loan
As discussed above, one way to mitigate risk to a lender is to have the loan “secured.” This really just means that some kind of collateral is being pledged as security for the debt obligation. If no security is pledged in support of a loan, then the lender is “unsecured.”
Being a “secured creditor” is preferable to being an “unsecured creditor.” An unsecured creditor will generally have a higher priority of claim for the debt owed, at least in respect of the collateral pledged by the borrower.
There are many different types of security that can be provided by a borrower to a lender. Some common examples (but not an exhaustive list) are the following:
- Land Mortgage. A Mortgage charges a parcel of land (and the buildings on it) as security for a loan. It also provides a lender with a variety of remedies in the event that the borrower does not make the required payments. Essentially, the lender can use a court (foreclosure) process to either sell the land, or have the land transferred to the lender, to recover the debt owed. A mortgage is registered against title to the land.
- Assignment of Rents and Leases. This document relates to land also. It essentially lets the lender step in and act as the landlord, and collect any rent payments payable. This applies when the borrower will be renting out the property, and typically operates only when the borrower is not otherwise making the required payments on the loan. This is usually registered (by way of a caveat) against title to the land.
- Security Agreement. This document charges personal (not land) property as security for the debt owed. It can be very general in nature and charge “all present and after acquired property”, or be specific and charge specific items (such as a vehicle, mobile home, etc.). Specific property is often identified by make, model and serial number. A security agreement is registered in the Personal Property Registry.
What if things go wrong?
Of course, borrowers do not always pay the amounts owed as planned. Depending on whether a debt is secured or unsecured, there are different remedies available to a creditor to collect on the debt owed. Your lawyer can prepare provisions in the loan agreement and security documentation to provide effective remedies when things go wrong.
If you are planning on being a lender, or have questions about collection of a debt (secured or unsecured), please contact us. We know business and we can help.