As many investors begin to approach or enter retirement, they begin to look for ways to increase their income. Often times, they seek ways to increase the amount of income generated from assets they already have. In today’s low-interest rate, low return climate, this type of gem can be difficult to find.
Luckily, there are two solid investment options that may be just what you are looking for: peer-to-peer lending and trust deeds.
Peer-to-peer lending can be a great way to generate monthly income at solid rates. Peer-to-peer loans are consumer loans that are not collateral-based. Borrowers generally use the funds from these loans to pay off existing high-interest debt, grow a small business or make home improvements.
If this investment option sounds like something you might be interested in, you can use sites like Lending Club and Prosper to find borrowers. After using their own algorithm to determine credit risk, these sites allow lenders to view prospective borrowers and choose whom they wish to lend to.
Lenders can expect to receive a rate of return between 5% and 23% depending on the creditworthiness of the borrower. These sites typically charge annual fees of 1% to 5% a year.
If you are looking for more of a hands-off approach, there are several funds that will invest in peer-to-peer loans on your behalf. These funds tend to require much larger investments than trust deed funds. Lending Club does offer several investment funds, but investment minimums are high, starting at $500,000.
A trust deed is a legal document that allows a borrower to transfer the title of a real estate property to a third party, a trustee, as security for the borrower’s debt. Here is a real life example of how a trust deed works: A real estate flipper wants to purchase a home that costs $400,000. Their goal is to update the home, do necessary repairs and then sell the property for a profit. Of the $400,000 asking price, the house flipper has just half or $200,000. If he attempts to borrow the $200,000 that he needs from a bank, he runs the risk of losing the property to a competing investor. To save time, he secures a loan from a private lender through a trust deed.
The trust deed allows the buyer to borrow the $200,000 he needs from a lender for a period of one year. A third-party loan originator facilitates and underwrites the loan. In exchange for the efficiency and convenience of this loan option, the borrower pays a much higher mortgage rate than usual, typically between 8% and 12%. For the duration of the loan, the borrower makes monthly interest-only payments and then a balloon principal payment at the end of the loan term.
Hypothetically speaking, if you were the investor in this deal and agreed to a 10% APR, you can expect to receive 12 monthly interest payments of $1,667 over the life of the loan. This adds up to $20,000. Best of all, at the end of the loan period, the full amount of your original investment is returned to you. Should the borrower fail to make his monthly interest payments, you become the owner of the property.
If you like the general concept of trust deeds but do not want to deal with the hassle of tracking deals down, you may want to invest in a professionally managed trust deed fund. Average annual returns for these loans run between 8% and 11% and minimum investment amounts start as low as $50,000. These funds also tend to require that their investors are accredited by SEC standards.
Since both trust deeds and peer-to-peer loans are held to maturity and have short loan terms, investors are protected from rising interest rates. With this in mind, these loans are not without risks.
If a borrower defaults on a trust deed loan and you are forced to take possession of the property, you may find that it is not worth what you invested in it. For this reason, it is important to always do your homework on a property prior to entering a trust deed. If you are concerned that you might not have the real estate knowledge to make a solid decision, consider consulting with an advisor who has a background in real estate.
Even trust deed funds have their risks. These funds may not necessarily protect you in the event that the real estate market crashes. Many trust deed funds fell through in 2008. You can help minimize this risk by investing in trust deed funds with a good track record during market downturns. Even this will not guarantee that they will survive the next one unscathed. Before you invest, always take some time to analyze the fund’s portfolio and loan loss reserves.
Peer-to-Peer loans are not without risk. Returns from these loans are based on loan repayments. In the event that a borrower defaults, there are no guarantees or protections for investors.
Always seek the advice of a financial professional before investing in peer-to-peer loans or trust deeds. While both investment types can generate great income during a time when returns are low, always remember to exercise caution.