Diversified Investing - Short and Long Term Loans

Having worked directly with hundreds of lenders over the years, I've seen an impressive variety of loan structures.  People are lending money for some of the most amazing reasons, and the returns vary from paltry to obscene.  Non-profits are lending without interest while ultra-high-risk lenders attempt to double their money in two months.

In this and the blog posts to follow, I hope to share my opinion on how lenders have succeeded in making a living by lending money.

Balancing stability, profitability, and cash flow is tricky for a private lender.  We need to ensure we have enough cash coming in to pay the bills and make new loans.  We don't want to have our money tied up in unproductive long-term loans, nor do we want borrowers to miss payments because the amount due is too high for shorter terms.

Creating a selection of loan products with varying terms can help you find the perfect match for each borrower.

Short term loans are excellent for borrowers with strong, steady income that require more capital for a prudent expense than they currently have.  One ideal situation includes an honest, hard-working borrower preparing for a large, non-frivolous expense.

For example, a very hard working friend of mine wanted to start a company, and in his good fortune he got an incredible deal to buy all the equipment he needed for $9000.  He came to my group of investors to see if we could lend him the cash.  We were more than happy to, since he already had a job where he was earning enough money to repay the debt, and the equipment was easily worth quite a bit more than the loan.  We made this loan, and the borrower chose an eighteen month term.  We charged a comfortable 14.9% interest and the deal was struck.  The borrower was very ambitious and his marketing savvy helped him repay the loan ahead of schedule.

Our short term lending allowed him to create a business.  Our money plus a reasonable profit was returned quickly so we could award it to the next deserving borrower.  Many lenders make fast, effective short term loans to responsible borrowers.  Examples include loans for unexpected bills, large but prudent purchases, loans to businesses to temporarily add inventory or buy assets, home renovation or remodel. 

Long term loans allow us to have consistency and to recover the expense of making the loan better than short term loans.  If a loan is well made, why would you ever want it to end?  And the early stages of the loan are rife with lucrative interest.

I've worked with many lenders who are also real estate investors.  When selling a property to a financially capable and thoroughly vetted buyer, they carry back a second mortgage.  (A "carryback", for anyone not familiar with the term, is when someone buys a house but only pays for part of it at the closing of the sale.  The seller agrees to take payments on the balance which is thereafter considered a second mortgage.)  This type of lending is very popular with real estate investors and sometimes non-investors find themselves playing the role of lender in order to get a house to close.

The loans typically run for ten to fifteen years and range from $5,000 to $200,000.  The interest rates are a little lower than short term loans - somewhere in the 8% to 11% range.  Of the payments made in the first year, typically 80% or more of the total cash received is profit.  Long term loans can really help your portfolio grow in size because the majority of the original capital is still invested but all the interest received can be readily made into new loans - significantly raising the amount of invested funds in the portfolio.

Long term loans require a deep assessment of the borrower before we hand out our hard earned cash.  If they're going to enjoy the fruits of our labor for ten years or more, we expect those fruits to multiply and ultimately be returned to us safely.  Once we're confident our borrower knows the nature of money and is prepared to make good on the commitment, we can watch our investments grow substantially from the long, steady and profitable repayment of the loan.

In addition to seller carryback financing, other popular longer-term loans include: automotive loans, educational loans, financing business purchases, and real estate mortgages.  Some of the more exotic lenders I've met have invested long-term in oil wells, wind farms, vacation properties, and multitudes of fascinating business ventures.  Whatever industry we know the best, there's probably a way our money will help someone else so that we both profit.

A good blend of short and long-term loans can provide us with a healthy rate of return, consistent cash flow, and opportunities to reinvest funds in a variety of scenarios.  Being flexible with the length of loans we make, we open ourselves up to greater opportunities to invest wisely.