How to Make Money From Private Lending

Invest in private lending to earn interest and make money

Australian investors have a long, rich, and profitable history with real estate investing. You could say, it’s in our collective DNA. And there’s no denying that investing in real estate is a smart move, especially in the Australian market where, despite the odds and a global pandemic, the market continued to grow and now remains steady.

But what do you do with all the money you make from your real estate investment portfolio? And what other options are there if you want to diversify your portfolio or don’t have the capital to put a deposit on another investment property?

While the Reserve Bank of Australia (RBA) has started increasing rates, investing in another property isn’t as attractive as it once was. But there is a way to invest in property without actually purchasing property: private lending. Haven’t really heard of private lending and are keen to know more?

What’s private lending?

Private lending, or private money lending, is exactly what it sounds like – using your own private capital to fund private loans. The loans are usually short term with the loan being secured against physical property (real estate) so it’s a different way of investing in property. It’s an increasingly popular alternative to traditional investment types like investment properties of shares.

The short-term and flexible nature of private loans means that borrowers are open to paying higher interest as they aren’t locked into a bank loan for 30 years. This is one of the reasons why investors and borrowers alike find them so attractive.

What’s a private mortgage?

A private mortgage is similar to a bank mortgage in that real estate property is held as security for the loan, but the money being loaned is sourced from private investors, not the big banks or credit unions.

What kinds of borrowers use private lending?

Borrowers who don’t meet the traditional lending criteria of big banks and financial institutions are the perfect private lending candidates – often business borrowers. As anyone who’s borrowed from a traditional lender knows, they have a strict set of criteria that offers very little flexibility.

Perhaps the borrower only needs the money for a short period of time or needs the funds urgently. Given that the average processing time for a bank loan is anywhere from six to eight weeks, that’s a lot of wasted time the borrower may not have at their disposal. To access this kind of money quickly and easily, borrowers are prepared to pay higher interest rates, which is great news for private lending investors.

However, private lenders don’t just lend to anyone. The mortgage manager conducts extensive due diligence before deciding to lend to a borrower.

How do private lenders make money?

As mentioned above, borrowers are prepared to pay higher interest rates for the ease and flexibility private lending offers.

What this means is that private lending rates are higher than those offered by the banks and other lending institutions, the terms of the loan are more accommodating for both the lender and the borrower and this is all secured by a nice piece of valuable Australian real estate.

The borrowers are sourced by the mortgage fund manager and extensive due diligence is carried out before the loan funds are provided. The mortgage manager is also responsible for managing the loan and making sure it is repaid on time. Once the loan is repaid the returns are distributed to the investors.

Most private mortgage investors choose to invest in a pooled mortgage fund which means their funds are spread across a portfolio of loans. This means that the investment is immediately diversified, rather than having all your eggs in one basket if you invest in one particular loan.

By investing in a pool of mortgages investors receive a regular passive income stream. Because everything is managed by an experienced mortgage manager, the investors don’t have to do anything except wait for that quarterly distribution to hit their bank account.

Is private lending profitable?

According to the Australian Financial Review, mortgage funds that lend money to finance residential, commercial and industrial property development projects deliver around 4% to 7.5% returns. Returns will tend to increase as the RBA increases the cash rate. 

Most private lenders pay distributions on a monthly or quarterly basis so it’s a great option for investors looking to earn a regular passive income.

Is private lending safe?

All investments carry a certain amount of risk but one way to mitigate risk is to invest in funds managed by experienced mortgage fund managers with a great track record.

The main way we mitigate risk, other than securing any loan with real estate, is to use a Loan to Value Ratio (LVR). Using an LVR, we don’t lend more than 75 percent of the value of the property being used as security for the loan. In fact, we usually lend a lot less than 75 percent.

Why do we use an LVR?

If a borrower cannot repay a loan, the mortgage holder, in this case, the mortgage fund, can sell the property to recoup the money loaned as well as any interest owed and legal fees. Should this happen, it’s important that the value of the property is more than the loan so that it is more likely that the lender can recoup all that is owed to them following the sale of the property.

What are the risks in private lending?

As with any loan, there’s the risk the borrower may default on the loan. One way to mitigate this risk is to do extensive due diligence before lending to a borrower and make sure they have a very solid ‘exit strategy’ – plan to pay back the loan.

We always suggest you do your own research as it’s really important you understand what you’re investing in and the risk involved. And always make sure any private money lender operates under an Australian Financial Services Licence.

If you have more questions or are ready to start talking about investing, we’d love to hear from you.

How do you become a private lending investor?

You can become a private lending investor by:

• Doing your own research and getting a solid understanding of how private lending works
• Seek independent financial advice about whether investing in private mortgages suits you
• Find a reputable private lender that you trust to manage your investment
• Decide how much you’d like to invest (remember, you can start with as little as $10,000 with APG)
• Read the relevant investment offer document (Information Memorandum or Product Disclosure Statement)
• Submit your Application and transfer funds
• Sit back and watch your passive income boost your bank account

When you consider the attractive returns and low minimum investment of private mortgage investing, the only thing you’ll be left to wonder is why you didn’t start investing sooner!

If you would like to find out any more information about Active Property Group’s pooled mortgage funds then please get in touch with [email protected].

This information is of a general nature and does not constitute professional advice. You should always seek professional advice in relation to your particular circumstances.

If you have any questions about investing in private mortgages then please send us a message via our Contact Page.