Investing in Debt: The New Bank
By: Leonard Hinton
Tags: Debt, Lending

Debt. What comes to your mind whenever you hear or see this? Liabilities or opportunities? For me, it’s both. Debt is not really something bad. Sometimes we use debt to cover some unseen financial issues that come along the way. Debt can be also positive in a sense that it produces something valuable like — a profit.

Investing in debt can be one of the best ways to see debt in a different light. When we invest in debt, we are like a bank. We indirectly or directly provide money to our clients. Same with the bank, the main purpose is to earn a regular income for a period of time. However, it is not guaranteed that you will gain the desired outcome over time. There are various factors that need to be considered prior to investing in debt.

Risk is always involved in every investment you will make. Just like the bank, you have the power to minimize the risks in debt investment. Aside from the fact that you can maximize your opportunity to earn profitable earnings and cash flow. As the lender, you can provide terms that are beneficial to you. You also get to choose who is eligible for the debt you are offering. You can decline an applicant application without a problem. And these are your rights as the lender — the bank.

Interest…Interest

Another good part of being the lender, you get to collect interest from each deal. This again depends on the agreement signed between you and the borrower. The interest you collect is like a blanket that can cover your expenses without harming your funds. Isn’t it great, you do not need to spend from your budget, instead you can pay other bills just by collecting interest.

Normally, these interests add up to taxable income. As a business rule, we need to pay our taxes based on the income that we get. If your interest collection gets really high, then paying your taxes in a quarterly manner is advised.

Tip: Always check your investment income. In case you get a tax bill of greater than $1,000, you should create an estimated tax payment throughout the year to avoid getting tax penalties. Check IRS for more details.

Safety Nets with Debt

How do some institutions remain steady with “investing in debt” businesses? Strategically, they have placed safety nets. These are commonly known as the cosigners and collateral. What do they do? Basically they are called safety nets because they are the one protecting the business- the lender.

Collaterals can be something of physical value like cars or title of a property. In cases where the borrower cannot afford to settle the loan, these collateral can be seized by the institutions as payment as agreed upon by two parties.

Cosigners are people that act as a backup source for loan payments. They are also the ones who help us get our loans approved. If your cosigner has a good credit standing, your loan has a greater chance of approval. If you are thinking of investing in debt, make sure to put in place these safety nets to avoid business loss.

Know The Risks with Debt

Investing in debt can be risky like other investments. The most common is the interest rate risk. Since change is constant, it also affects the debts businesses. Interest rate risk happens when your money is being tied up to a long term agreement and the interest rate rises. Therefore, it is not always good to have a long term debt agreement especially if the interest is not so big.

Another risk I would like to mention is what I called quick cash risk or commonly known as liquidity risk. Liquidity in its simpler form, is the potential of the funds to be converted to cash. Houses and cars are samples of illiquid assets. It takes time to convert them to cash. When a debt was agreed to be in a longer period of time, the liquidity of the funds will be overtime as well.

Lastly, the most common of all — default risk. I say this is the common of all. When a borrower fails to pay the debt that is called default. All lending companies have records of default risks.

You can try to lessen default cases by placing safety nets and reviewing the credibility of the applicants. Read about DIY Credit Repair Book and secure your financial future.

We invest to make our funds more profitable resulting in achieving our financial goals that can give us a comfortable life in the future. Debt-based investment can have advantages or disadvantages depending on the individual and the business. Bottom line is, before you decide to move to your next investment story, know them first.