Two ways to get investment income in a low-return environment(Read article summary)
Investment income can be scarce in low-return environments. Read more to learn about two ways to maximize investment income, despite the environment.
Many investors preparing for retirement, or in the early stages of it, are seeking ways to substantially increase the amount of monthly income they generate from their assets. These are tough to find in today’s low-return, low-interest-rate environment.
Fortunately, there are two investments that are worth considering: trust deeds and peer-to-peer lending.
If you’re comfortable with real estate investing, consider trust deeds, a type of private real estate loan. Institutional investors favor these loans, but they can also work for individuals.
A typical trust deed arrangement might start this way: A real estate entrepreneur wants to purchase a $500,000 house, hoping to rehab it and sell it at a profit. He has $250,000, but needs to borrow the other $250,000. If he waits for a bank loan, a competing investor might snap up the property — so to save time, he goes to a private lender for a trust deed.
Under the trust deed, the buyer borrows $250,000 from the lender — working through a third-party loan originator who underwrites and facilitates the loan — for one year. For the speed and convenience, the borrower pays a much higher rate then he might for a mortgage, typically 8% to 12%. In most cases, the borrower makes interest-only payments each month and a balloon payment of principal at the end of the term.
Let’s say you’re the investor in this deal, and you agree to a loan at 10% APR. If all goes well, you’ll receive 12 interest payments of $2,083 each, totaling $25,000, and at the end of the year, you’ll get your $250,000 back. And if the borrower fails to make the monthly payments, you take possession of the property.
There’s no set minimum for investing in a single trust deed. They can be fractionalized — that is, divided into several portions — but loan originators generally prefer to deal with one investor per loan.
Finding trust deeds in which to invest can be difficult. Your best bet is to reach out to advisors or brokers who have established relationships with originators in the space.
If you like the concept of trust deeds, but don’t want to hunt these deals down, you might invest in a trust deed fund run by a professional manager. These funds currently pay between 8% and 11% per year and have minimum investment amounts that start around $50,000. They also tend to require investors be accredited by SEC standards.
Peer-to-peer loans are another way you might be able to generate monthly income at decent rates, provided your state permits it (most do). These are consumer loans that, unlike trust deeds, aren’t based on collateral. Borrowers typically use proceeds to pay off higher interest rate credit cards, fund home improvements or grow a small business.
If you’re interested, you can find borrowers through online marketplaces, such as Lending Club and Prosper. On the sites, lenders can view prospective borrowers and decide to whom they want to lend – and the interest rate they want to charge – using an algorithm that determines credit risk.
Lenders receive rates between 5% and 23% on loans, depending on each borrower’s credit. Lending Club and Prosper charge fees of about 1% to 5% annually.
There are also funds that will invest in these loans on your behalf, but these funds often have higher investment thresholds than trust deed funds. Lending Club offers several funds that invest in its loans, but investment minimums start at $500,000.
Both trust deeds and peer-to-peer loans can protect investors from rising interest rates, because they’re held to maturity and have short durations. But they also have risks.
If your trust deal goes sour and your borrower forces you to take possession of the property, it might be worth less than your investment in it. So it’s important to do your homework before investing. If you’re not up to this, consider hiring an advisor with experience in this market.
Investing in a trust deed fund won’t necessarily protect you from real estate market crashes. Many, though not all, trust deed funds went bust in 2008. I like to invest with trust deed funds that have a good track record through multiple down markets — but this doesn’t guarantee that they’ll make it through the next one. Before you invest, analyze a fund’s portfolio and loan loss reserves. As with individual trust deeds, you may want to have a professional do this.
Peer-to-peer loans also carry risks. Returns from both sites are based on loan repayments, and there are no guarantees or protections in case borrowers default. Lending Club and Prosper both recommend that investors spread their investments over several loans, reducing the impact if any one borrower fails to repay them.
If you do invest in peer-to-peer loans, your investment should be part of a diversified investing strategy, and shouldn’t represent your life savings. Lending Club notes in its prospectus that investing is suitable “only for investors with adequate financial means,” “who can bear the loss of their entire purchase price.”
It’s critical that you educate yourself or seek the help of a financial professional before investing in either trust deeds or peer-to-peer loans. But if you exercise due caution, both of these types of investments can be great income generators at a time when investments that produce good returns are few and far between.
This article first appeared at NerdWallet.