The lazy strategy to lend money for profit

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Reza Machdi-Ghazvini,CAIA
Last updated on 03 September 2021

The lazy strategy to lend money for profit

You might think about lending money privately because this has advantages for you and the borrower. You get some interest and the borrower can avoid the much higher interest rates of banks.

People who lend money privately often do so within their family or to friends. But this can result in very unexpected and unpleasant events, as some might have experienced already in the past. It is not without reason that many people say: a debt paid is a kept friend.

In this article, we would like to show you what you should consider contractually, practically and fiscally when you lend money privately. As an alternative to private loan transactions, we present you a lazy strategy with which you can also achieve attractive returns without too much effort.

Lend money privately

Before you lend money privately, you should first ask yourself what can go wrong and how you want to respond. For example, if you lend money to a private person who subsequently becomes ill or unemployed, this could be a reason to at least defer the loan for a while. Otherwise, your insistence on repayment (and interest on the loan) could be seen as inconsiderate.

Likewise, you need to ask yourself how you will eventually prove that you lent money. If you do not transfer the loan amount, there would be no actual proof that you lent money to a person.

Set up a private loan contract

If you lend money privately, you should draw up a private loan contract. In the contract, you should record at least the following points:

  • Names and addresses of the lender and the borrower

  • Date when the contract was concluded

  • Amount of the loan

  • Repayment and interest interval

  • Possible collateral

The loan agreement should then be signed by you and the borrower.

Risks with personal loans

The credit business, or loans, has been around for several centuries - according to Wikipedia, already since 3,000 BC. While the credit business has changed over the centuries, it has always remained the same at its core.

A borrower borrows an amount that he must repay after a certain period of time (credit period). The borrower must pay interest on the amount loaned.

In this context, credit transactions always involve the same risks, which lenders in particular must consider because they bear the risk of not receiving the loan amount back.

Put simply, you as a private lender can be affected by the same risks that can affect a bank in the lending business, with additional risks on top of that.

Default risk

default risk

The classic risk in loans. Default risk describes the risk that a borrower may become insolvent and be unable to repay the loan amount.

The lender then has the option of deferring (suspending) the loan and interest in the hope that the borrower will be able to service the loan again in the near future.

If a loan defaults permanently (or partially defaults), you must write off the loan amount.

Concentration risk

If you lend the same loan amount of €500 to 10 borrowers and one of the borrowers subsequently goes bankrupt, this is annoying for you, but you have at least €4,500 left of your lent capital.

Assuming a remaining loan term of 1 year, the other loans would have to pay you 11.12% in interest to recoup your loss (€4,500 x 1.1112 = €5,000).

The situation would be entirely different if you lend €5,000 to a borrower who then defaults. In this case, there would be no realistic chance for you to recover your money.

You have to be aware that this risk can fully affect you if you privately lend higher amounts to only one person.

Other non-financial risks

With personal loans, there is also the private component. Lending money to friends or family members can end badly.

Especially if you lend money in a private context, you should clarify all rights and obligations contractually. It often happens, for example, that friends expect an interest-free loan and then react disappointed that you demand interest.

But also in the non-family and friend environment, you have to consider that you lend money to other private persons. For example, what would you do if a private borrower you hardly know does not pay you interest or had fraudulent intentions from the beginning? In this case, you would have to go to court to try to get your money back, which could be very annoying and expensive for you.

Profitable private money lending is very time-consuming

You should also not underestimate the time factor. With every personal loan your workload increases. You have to control whether the payments come in, and you also have to assume that, sooner or later, a borrower does not meet the obligations.

As you may have noticed, due to the concentration risk, you must not lend too high amounts to individual persons. To pay enough attention to this risk, you will have to lend money to several borrowers, which will increase the time required.

Taxes on personal loans

Interest from personal loans is considered income for tax purposes (interest income) and must be listed in your tax return.

Depending on the country, interest income may be taxed like capital gains. In Germany, for example, this means that you have to pay between 26.38% and 27.99% of your interest income as tax to the tax office.

If you do not declare your interest income, this could be considered tax evasion by the tax office, which could have fatal consequences for you.

The lazy strategy to lend money privately

automatic investing

If you want to lend money privately, we can introduce you to a lazy strategy that allows you to earn attractive interest without having to invest a lot of time.

In recent years, P2P lending has become more and more established as an asset class in Europe. With P2P lending, users lend money to each other on P2P platforms. In Europe, for example, Mintos has been able to establish itself as the largest P2P platform by loans mediated, offering investors returns of 10-12% p.a. on average.

Limit default risk and concentration risk

The minimum amount to invest in P2P loans depends on the P2P platform. Typically, it varies between €10 and €25 per loan. This is very convenient for you because you could, for example, invest an investment amount of €1,000 over 100 loans. This way, you could significantly reduce both the default risk and the concentration risk.

Automatic investment function on P2P platforms

On all major and well-known P2P platforms, you can now allocate loans via an automatic investment function. Once you have set your preferences, the automatic investment function will select P2P loans for you and will also automatically reinvest the returned funds for you.

This will save you a lot of time and you will only have to check occasionally if everything is in order.

Implement the lazy strategy now

If we have now aroused your interest in P2P lending and you have had little or no experience with P2P lending, we recommend our P2P lending review that offers you the P2P basics and a review of the best P2P lending platforms.

With P2P platforms, you can grant personal loans very efficiently. The platforms take a lot of work off your shoulders by taking care of all the steps of loan mediation for you. This includes handling delayed and defaulted loans.

To begin with, it is important that you learn about the asset class, after which you can implement your own lazy strategy.