Lending Money SMARTLY (My Tips On: Interest, Risks & Friends / Family)

A Step by Step Guide on How to Lend Money. Explaining the different types of lending, the loan agreement, interest rates, risks of money lending to friends / family (or anyone) and each stage of being a lender.

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With money lending and all other forms of investment, it is essential to speak with your financial advisor, accountant and/or a lawyer.

My experience in money lending includes property developers, commercial property investors and businesses that need extra working capital. It's worth noting that lending money as a business to private borrowers needs a licence in Australia.

There is a range of different security levels, commonly known as the capital stack. The highest-ranking of security is primary debt. Followed by the subordinate debt, and finally unsecured debt. There is also a different type of structure called preferred equity, whereby you don't have security over the asset, but your returns are ranking in preference to the ordinary equity holders.

The interest rate when you are lending money is based off a range of factors, but the main is the rank of security you have over the asset.

A high-level process of lending money:
Loan term sheet
Due diligence on security / deal / borrower
Loan agreement documents
Settlement
Registration of security
Intertest
Repayment
Discharge of security

I will also cover off on a few extra important areas to understand if you're considering lending money to a friend or family include:

Knowing the concept of a separate legal entity. Whereby if you lend to a company, you may not have security if the company assets sit outside the company or another lender has security over those assets in preference to your loan agreement.

The interest rate of the lending has to be considered fair and reasonable. If your nominated interest rate in the loan agreement is too high and challenged by the borrower, the court can reduce the rate, void parts of the loan contract or do other things within its power to make the lending agreement fair.

If the borrower defaults on the loan, and you have the right to sell the assets. Any funds in excess of remedying the loan agreement will go back to the borrower. Meaning you can't just take assets over and above the lending agreement.

Be careful of personal guarantees. They aren't always worth the paper they are written on. Do thorough due diligence on what assets are owned in the personal name of the borrower and be sure to have the loan agreements done correctly.