How I Make Money from Private Lending

There are lots of ways to invest in real estate, from rental properties to REITs. One of the best ways I have found to invest without having to actually own physical property is with private lending investments.

Private lending is simply when one private individual or entity loans money to another. Usually, a piece of real estate is put up as collateral for the loan.

Real estate investors tend to use private money rather than long-term mortgages for their short-term real estate investment projects such as fix and flips, or rental property investments.

Passive investors usually take the position of lender, using personal funds or their retirement account to lend.

This partnership tends to work very well for both sides. The real estate investors get to access quick, flexible funding. At the same time, the lender gets to earn regular monthly passive income at a great rate of interest.

So, how do you make money from private lending?

Well, I’ve been involved in the real estate space as a lender, borrower and broker for over 10 years. I’ve helped tons of investors originate hundreds of private lending investments. I’ve also used private money loans to build my own rental property portfolio of around 70 houses.

Here’s exactly how I make money from private lending…

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Interest and Points

The most obvious place to start is interest. In the world of private lending. As a lender, the interest rate you charge should reflect the ‘riskiness’ of the loan.

Variables like loan-to-value, collateral quality, and the credibility, capability, capacity, and competency of the borrower – amongst other things – all play a part in creating an overall picture of the risk of any loan (and how much interest you can reasonably charge).

In the world of private lending, interest comes in two forms:

1. Interest on principal
2. Points

Interest on Principal

This is the interest rate you charge on the loan amount. For example, if you’re lending someone $100,000, and you’re a charging an interest rate of 8% p.a., you will be charging $8,000 p.a.

That’s $8,000 per year in passive income (providing all goes well).

Private money loans are typically interest only. That means that the interest is charged monthly, with a further balloon payment at maturity to repay the original principal amount.

In the case of our example here, a 12-month of $100,000 with an 8% p.a. interest rate would work out to 12 monthly payments of $666.66, and one final balloon payment of $100,000.

Points

In addition to interest on principal, private lenders also often charge points.

Points is just a fancy way of saying upfront interest. It works like this…

One point is equal to one percentage point of the principal loan amount. So, if a loan of $100,000 has an interest rate of 8% p.a. and 3 points, the borrower would pay the lender an additional $3,000 (3%) when the loan is closed.

In this case, if you were the private lender, you would earn:

An initial payment of $3,000

$8,000 in interest (12 monthly payments of $666.66)

That brings the total amount of passive income you would earn from this investment to $11,000.

So, to sum up… If you loaned $100,000 to someone at 8% p.a. with 3 points, you would earn a total of $11,000. That equates to an annual return on investment of 11% p.a.

Bot interest and points aren’t the only ways to make money from private lending investments…

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Loan Origination Fees

Another way I have made money on most of my private lending investments, is to charge my borrowers various fees for the time and effort I put in underwriting and preparing the loan.

These upfront fees can include:

1. Origination fees
2. Documentation fees
3. Underwriting fees

Some lenders have other fancy names of these types of fees, but I like to keep things as simple and clear as possible.

At the end of the day, it takes time, effort, and resources to underwrite a loan. There are a lot of checks and points of verification to sign off on before I part with any cash.

I want to make sure that all of the information presented by the borrower in relation to the property, project and themselves is true, up to date, and in order.

I have charge origination and documentation fees of up to $3,000 per loan.

In the case of our existing example, that means your total earning from this loan just went from $11,000 to $14,000.

That’s an annual return on investment of 14% p.a. Not bad for a loan with an interest rate of just 8%!

Other Fee Income

The final way to make money from private lending investments is in late fees and default interest.

Now, if you’re charging late fees or default interest, it means the loan hasn’t gone to plan, so it’s not really a good thing. With that said, if your underwriting is on point, you’ll likely recover all your interest, late fees and default interest in the end.

Late fees vary from one lender to another. Personally, I charge 10% of the missed interest amount. So, if our theoretical borrower was late with a payment of $666.66. I could charge an extra $66.67 for that month.

Default interest is a little more complex. This is where you would charge a much higher rate of interest in the loan fell into default.

Default interest is enough of a subject in its own right, so I’ll be writing an article about that soon.

For the purposes of this article, we’ll say that personally, I do not write default interest into my loans. But, I have seen lenders write loans with a default interest clause charging up to 25% p.a.

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Conclusion

So, there you have it. There are really 4 ways to make money with private lending investments:

1. Interest
2. Points
3. Origination Fees
4. Late Fees

Of course, there’s more to this subject than just that…

For example, as a private lender I have foreclosed a loan and finished the real estate project myself. In doing so I made a tidy profit far over and above what I would have made as a lender.

For now, let’s assume your private lending journey starts out well and you don’t end up foreclosing. In that case, you should see returns in the region of 8% to 15% p.a. form your private lending investments across all forms of income discussed here in this article.

Good luck, and happy lending!

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Further Learning:

• A Guide to points from Rocket Mortgage
• National Private Lenders Association Guide to Default Interest 
• Investopedia Guide to Mortgage Origination Fees