If you’re hoping to start a business, one of the most profitable is offering personal loans to others. However, getting the startup cash and investors required can be challenging.
Before you decide to start a personal loan business, it’s important to understand the ins and outs and be prepared for potential setbacks.
KEY TAKEAWAYS
- A personal loan business can be flexible and profitable.
- You need investors to back a personal loan business, and it can be challenging to find them.
- It’s important to prepare ahead of time with paperwork, including loan documents.
- Federal, state, and local laws can make starting a personal loan business challenging, and you should review necessary information before moving forward.
Before you move forward with a personal loan business, you need to decide if it’s the right path for you. There are different potential ways to move forward with a personal loan business. Some potential options include:
- Your own money: You lend your own money to others. You can choose to provide secured loans or unsecured loans. However, you need to have a large amount of capital to get started, since you’re using your own money to move forward. In this case, though, you keep all the interest paid on the loan and can charge what fees you wish.
- Investor money: With this type of business, investors provide you with the funds to make loans. The investors receive the interest from the payments, and you receive compensation in the form of a loan fee charge at origination.
- Peer-to-peer (P2P) lending: Rather than directly lending money, you provide the means to connect borrowers and lenders. You might do it through an app or website. You take a cut of the deal but aren’t putting up your own money to get started.
A personal loan business can be profitable since you have the chance to earn money upfront from origination and administration fees. Plus, depending on how you set up your business, you might be able to benefit from the interest earned on repayments.
On the other hand, though, you have to be prepared to shoulder some of the risks. If a borrower misses payments or defaults, you could lose money—especially if you’re lending out your own money.
Don’t forget to consider the market potential as well. Loans are popular, and it’s possible to find customers all over the world. Even so, the industry has slowed in recent years, and there are concerns that increased scrutiny for moneylenders could lead to more challenges for those who want to start a personal loan business.1
Pros and Cons of a Personal Loan Business
Potential for good profits, including upfront cash flow from charging fees
Flexible business model that can be managed from home if you choose
Customers available from a variety of markets, since many people need loans
Regulations can differ at the federal, state, and local levels, and it’s hard to predict how you need to comply.
It can be difficult to get enough capital to start, whether you use your own money or look for investors.
Growth in the installment loan industry has been slowing in the last few years.
Make sure to carefully consider the pros and cons of a personal loan business before you get started. Realize that regulations and the need for capital can make this a challenging business, even if you have the potential to make a good profit.
Don’t forget that heavy regulation at various levels of government can regulate how you collect interest, who you can lend to, and other aspects of personal loans. Working through the different regulations can be challenging, and it’s important to remember that financial services come with a lot of red tape. In fact, it’s important to note that there’s no one-size-fits-all approach to a moneylender business. You probably won’t be able to take one business template from one place and apply it to the same loan business in another location.
Develop a Business Plan
Next, you need to create a business plan. Unless you’re using your own money to fund the loans you make, you’ll need investors and other backers. Most of them aren’t likely to provide you with the money you need to get started unless you have a good business plan.
Some of the main elements of a business plan include the following:
- Executive summary: This is the overview of your business plan. It provides a way for investors and others to quickly understand the basics of your idea and how you expect to make money. It should be the last thing you write, even though it will be at the beginning of your overall plan.
- Business summary: Describe your business in this section. It should be an overview of what you hope to accomplish with your business and your goals. Key people in your company should be recognized here, along with their skills and what they contribute to the success of your business.
- Products: Be clear about what you’re providing and how you plan to deliver. Make sure you’re clear about the types of loans you’ll provide. This can include whether you plan to focus on microlending, traditional personal installment loans, cash advances, or some other type of loan. You can also share whether you plan to provide options such as allowing co-signers or accepting collateral.
- Market analysis: Next, you need to provide an analysis of your target market and potential demand. You’ll need to back this up with research and have an analysis of what type of growth you can reasonably expect, in addition to potential challenges.
- Competitive analysis: Take a look at your likely competitors in the space. You should be able to compare their strengths and weaknesses to your own and provide an overview of how your product and business will be advantageous compared to your competitors.
- Marketing plan: Provide a marketing plan. How will you reach your target market? What channels will you use, and do you have any promotional strategies? Flesh out a plan to show how you will reach customers and convert them.
- Operations plan: This section is all about logistics. Where will you be located? Will you have offices or operate online? Do you have special equipment or people who can be used to make this business a success?
- Financial plan: Don’t forget to lay out the numbers. In general, you should plan to have projects for startup costs and the type of investment you’ll need. Provide profit and loss estimates, and detail your expected cash flow. You should be able to estimate three to five years.
- Appendix: If you have any supplementary materials and documentation, it should go in this section of your business plan.
Form a Legal Entity
Once you have your business plan and a roadmap for the future, you need to form your legal entity. Decide whether you should be a sole proprietor or if it makes sense for you to form a limited liability company (LLC) or some other partnership. You can also form a corporation. An accountant or a business attorney can help you figure out what type of structure makes sense for you.
If you think you’ll hire others to work in the business, or if you have investors who might want to be partners, you’ll need to keep that in mind as you form a legal business entity. Depending on your state, you might need to file articles of organization and register your business with a city or state office.
Register Your Business with the IRS
You’ll need an Employer Identification Number (EIN) from the Internal Revenue Service (IRS) as you move forward. This will be used when you file your business or partnership tax returns. You can go to the IRS website and get an EIN and register your business within a matter of minutes. It’s also possible to complete this step by mail or fax.2
Figure Out Financing
One of the most challenging parts of starting a personal loan business is making sure you have the financing you need. If you’re going to loan money, you need a significant amount of capital.
If you’re using investors’ funds, you’ll need to build relationships and convince others to provide you with capital to lend to others. You’ll need to have agreements in place with your backers so that they know how much they can expect, including what types of returns they’re likely to receive.
All of this can require a lot of expense as you consult with lawyers and make sure you’re in compliance with federal, state, and local regulations.
Get the Required Licenses and Permits
Next, you need to figure out what licenses you need to operate a lending business. You might need permits as well, especially if you’re occupying a building. States, counties, and cities might have their own rules. These rules will be based on whether you operate out of your home or another location. Make sure you understand the requirements before you move forward and get the appropriate paperwork filed to operate legally.
Remember, too, that you might have to get certain licenses for financial services, depending on where you operate. Taking the appropriate tests and paying for the licenses can be costly, so evaluate whether this is something you want to pursue.
Set Up Business Accounting
Don’t forget to set up business accounting. You should have a separate system from your personal finances. You’ll need bookkeeping and payroll for employees. You also need a way to keep track of when borrowers make payments and how much of each payment should go toward the principal and how much should go toward interest. And, if you have investors, your accounting should also take into account what’s going to them.
Get Business Insurance
As a moneylender, you need business insurance to protect you if too many borrowers default or something else happens. Often, you might need business insurance to protect you in the case of lawsuits as well. If you have a building, you’ll need insurance to protect your premises. Don’t forget about workers’ compensation as well. There are many different types of business insurance, and you need to make sure you’re paying for policies that fit your needs and can help protect your assets.
What to Expect When Opening a Personal Loan Business
When you open a personal loan business, you should be prepared to work long hours and be ready to market yourself and your business. It’s also important to make sure you have enough capital available to fulfill the loans you plan to make to others, as well as meet all federal, state, and local regulatory requirements.
Understand how to put processes in place when deciding whom to lend to. Check with local regulations on how to evaluate someone’s creditworthiness and the types of agreements you need to have borrowers sign. Don’t forget that some states have caps on the interest you can charge on loans, so you should know how to set annual percentage rates (APRs) (which include origination and other fees) to be compliant.
You also need to set up payment systems to collect payment (plus interest) from your borrowers. This can include online systems, mail-in, or other arrangements. If you plan to automatically deduct from accounts, you need to have the right agreements in place and get permission for auto-drafts from bank accounts. All of this needs to be done with regulation in mind and best practices for security. You must be prepared to issue account statements to each borrower, showing them how much of each payment is going to the principal and how much is going to interest.
Don’t forget to create a collections policy. You need to have an idea of how to pursue nonpayment if someone falls behind. Once again, it’s important to make sure that how you approach collections is according to federal, state, and local regulations on personal lending businesses.
You should also have insurance and investors prepared to help you manage your business finances if you have people defaulting. To reduce the chances of default, you might need to consider how you will vet borrowers, including running credit checks and deciding what minimum credit score you’ll require.
Additionally, you’ll need to have policies for handling sensitive personal finance information. You’ll likely have to collect information regarding Social Security numbers (SSNs), bank accounts, and other sensitive matters. You’ll need a way to protect your database and have protocols in place for keeping personal data secure.
How Do I Start a Private Lending Business?
In many cases, you need access to a large amount of capital to start a private lending business. This can come from your own finances, or you might need to get money from investors. You also need to meet specific regulations in your state and get the appropriate licenses, insurance, and permits to start a lending business.
How Does a Moneylender Business Work?
In a moneylender business, a lender provides cash to a borrower. The borrower pays interest, and they might even pay origination fees and other costs. As the borrower repays the loan, more capital is available for other loans, and the lender makes a profit from the interest they receive.
How Do Loan Providers Make Money?
Loan providers usually make money by charging interest on loans. The interest charge is normally part of the repayment process, and how the lender is compensated. Loan providers might also make money from fees they charge, including origination and administrative fees.
The Bottom Line
A personal loan business can be a profitable way to earn money. It’s relatively easy to manage, as long as you have a good system for keeping track of the progress of loan repayment. However, you need access to capital and need to be prepared to go through the regulatory process. Also, many loan businesses need good legal representation to help them navigate laws and regulations, in addition to drafting loan agreements and other documents.
Before you decide to lend money to others, carefully consider your situation and whether it makes sense for you to get involved with a personal loan business.
Source: https://www.investopedia.com.
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