The purpose of this article series is to give family, friends, businesses and other organizations a guide to 1) making private loans to family, friends, family businesses, or non-profit charitable organizations; and 2) borrowing from family and friends.
The current inflation (and associated high interest rates) has made it more difficult for consumers, small businesses, and non-profit organizations to qualify for loans. What’s the solution? We believe that “family and friend” loans are a viable way to help family and friends, revitalize the economy and even create jobs. And private lending can be done safely and prudently.
Would you consider inviting your family and friends, your social network, to make a loan to a responsible family member, friend, business or charitable non-profit organization?
It is our thesis that the loans among your family and friends and your social networks can benefit the lender, the borrower and the community in many ways. We’ll discuss the benefits of family, friend, small business, and non-profit lending as well as the guidelines to consider if you decide to make your loan.
The Benefits of Family and Friend Lending
Do you have the passion to make a loan? A loan, properly underwritten, will help the borrower achieve goals and maybe even fulfill someone’s life passion.
But making a loan takes a mental and financial commitment. The lender has to be willing and have the financial capacity to make the loan. And the borrower needs to be willing and able to pay it back.
Whatever your reason to consider making a loan, only do so if you have the capacity to do so and losing the money won’t significantly change your lifestyle. Be honest with the borrower. If you cannot afford to make a loan, tell the borrower so. Creating a financial hardship for yourself will not serve either you or your borrower’s best interests.
So if you have a passion for helping and the financial capacity to help, forge ahead.
Why would you lend money?
What would motivate you to make a loan to a family member, friend or non-profit organizations? We hear the following comments from our ZimpleMoney members. “You lend money because it feels good and I want to help.” “It provides me great mental satisfaction and a personal sense of accomplishment to know that I contributed to a positive change.”
We just can’t help ourselves! Humans innately want to give, volunteer, and help. If the mental benefits are not enough, how about the tangible benefits that lending with a purpose will have on others:
- Capitalize a great idea
- Help family buy or improve a home
- Start a Charter School
- Finance the purchase of a school building
- Earn more interest than at a bank
- Below market interest rates to your borrowers
- Help make a passion a reality
What are your reasons?
Criteria For Underwriting a Loan
The “five C’s of credit” is a method used by lenders to determine the creditworthiness of potential borrowers. The system weighs five characteristics of the borrower and helps gauge the chance of default. The five Cs of credit are:
- Character: the borrower’s reputation
- Capacity: the ability to repay a loan (is the income and or the collateral sufficient to repay the loan)
- Capital: the amount of capital the borrower has contributed toward the investment (human or financial capital)
- Collateral: security for the loan (car, boat, property, stock etc.)
- Conditions: what is the current economic conditions and terms offered by the borrower
All 5C’s are important, and not all are simple to assess.
Character is usually a judgment call. If you know someone, you’ll have an understanding of the person’s character, good or bad.
Capacity is a tangible measure of someone’s ability to pay. More on that below.
Capital can be subjective if measured in hours committed to a project or know-how. Keep in mind not everyone has the financial capital to invest. They may bring tremendous human capital resources to a project, business or community. So when evaluating projects keep the two types of capital in mind.
Collateral is a tangible measure as well. Many private loans are not secured by anything other than someone’s personal commitment to pay it back. If you are helping someone buy real property, a school building, church, a car, or other tangible property, you might want to consider securing your loan with the property being purchased. Additionally, there is nothing that precludes a lender from taking collateral in something unrelated to the loan. Maybe a second trust deed on a house or land, or whatever might be available.
Conditions are a very subjective measure. Knowing the conditions of a local market may be more important than understanding that the National unemployment is over 9.5%. What I mean is that there may be terrific local reasons that are screaming make the loan that may or may not be supported by the larger view of the US economy. This is one area where gathering all the criteria may make a big difference in whether you want to risk lending.
All five factors need to be weighed before making a decision on whether or not to lend money.
Next up: Part 2 – Information for Borrowers