Pretty much everyone has that friend or family member who is always asking to borrow money (or maybe YOU are that friend or family member). Maybe it feels nice to be recognized as doing well enough for yourself that you can spare some cash. And maybe you like helping people who need it! But if you’ve been on the lending-side before, you’ve probably wondered how to decide whether or not to lend money. Let’s talk about becoming a lender!
If you recognize that you are fortunate financially and are interested individuals in need, one thing to consider is micro-loans.
These are loans of small amounts of money such as $25 or $50 to someone in another country. $50 might not seem like much to you, but it can mean the purchase of a goat or the start of a business to someone else. The loan is slowly paid back to you with a small amount of interest over time.
Kiva.org is a great option to look into if this is something that is of interest to you!
Another type of loan is those given to peers, family members or friends. You can charge interest and set up a tailored repayment plan that works for everyone. This is a great way to help someone close to you without losing money yourself.
Thirdly, venture capital loans are a way to invest in a growing company in exchange for a compensation return in the form of (hopefully) growth of equity and dividends.
When considering which types of loans to give, its important to recognize the situation. Do you have a trusted family member who is going through an unexpected emergency and needs cash immediately? This might be a situation where you would jump in and help out without a second thought!
On the other hand, perhaps your acquaintance has been asking you for “just $100 one more time” every month for 6 months. In this case, you could give them $100 again, but you can probably expect that you won’t get your money back and they will probably ask you again next month.
Perhaps instead of helping you are actually perpetuating an issue. It might be more helpful for you to offer to review your friend’s budget or provide them with some of Isaiah Goodman’s blog videos. Or if the $100 is to keep their small business going, perhaps giving them $1k immediately will allow them to completely fix the issue and begin to become profitable.
When you do loan money that you expect paid back to you, it is important to set clear timelines and interest rates from the beginning.
Do you want to be paid back within 2 years? And do you want monthly payments or yearly payments? Will they give you cash or send a check to your bank? You will also want to make sure you both agree on how interest will be calculated. APR (annual percentage rate) of 10% means a flat 10% each year while APY (annual percentage yield) can be significantly higher if 10% interest is compounding, for example, on a daily basis.
Do you understand the time value of money? If you have $10k to invest in two different ways, one will probably give you a better return over time. For example, $10k invested at 5% over two years is not worth as much as $10k invested at 8% interest for 6 months. In the second option you only made 4% back on your money, but you made that in only ¼ of the time, and now you have another 18 months to invest your $10k (plus the 4% interest) in another way!
Finally, when you are considering a venture capital investment, it's important to understand how your money grows.
You typically won’t receive interest, but instead you’ll see changes in equity and dividends. If you invest $10k into a business that is worth $100k, you own 10% of the business. Now if the business does well and grows to become a $1 million company, you don’t just own $10k…you have 10% of the company so now you have $100k in equity!!! Of course there is always the risk that the business does poorly and you could lose money as well, so it is best to research and invest carefully!
You are now ready to become a lender - Loan wisely!
Want to chat more about lending and tips? Schedule some time with Becoming Financial Below.