Financial investors are quick to suggest that investors diversify. One of the best ways to diversify your investments is to loan money to others. Effectively, you are the bank. You are entitled to the return of your investment (principal) and interest on the loan. By lending money to others, you are letting your money work for you

The key to collecting a debt is to make sure you have enforceable documents. It seems simple, but I can’t tell you how many people come into my law firm and say that they don’t have a contract. Of course, if you were to borrow money from a bank, you would need a contract, a personal guarantee, and a security instrument. So if you are going to lend money to your brother, friend, or really anyone else, you should have a contract, a personal guarantee, and a security agreement in exchange for lending the money.

The contract:  A bank generally requires a contract specifying all the material terms, including (1) the term (how long), the interest, and what happens upon default.  For instance, if the payment is late, are you entitled to attorney’s fees, late fees, or default interest?  Of course, without a contract, you would have to rely on the court to give you these, and from my experience, the judge likely won’t give you any of these.

The Personal Guarantee: If the borrower is a business, a bank would likely require a personal guarantee to lend money.  Thus, you should have borrower sign an agreement to be personally liable for the debt.  At least in Arizona, this is necessary to have both the husband in the wife sign an agreement.

Security Agreement:  A bank is always thinking about what happens if you default.  You should to.  In the event that the business doesn’t have the money to repay the debt, the bank will take a security interest in your house.  In Arizona, the bank takes a deed of trust to secure repaying.  If you default on your loan obligation, then the bank can foreclose upon the deed of trust to pay off its principal, interest, late fees, and attorneys fees that accumulate in the process of trying to collect the debt.

There are several types of security instruments. Contact an attorney if you would like to know more.

The point of this article is that the best way to collect a debt is to have enforceable documents. As you are lending money, these documents are the first and best line of defense to minimize your risk of giving the money to someone else. Of course, our firm has helped countless investors draft the correct documents to minimize the risk of lending money to another.

Lending money is a great way to earn passive income. If you do it right, you can minimize your risk of losing your investment. The attorneys at our firm are excited to help you protect your investment and to put you on the road to passive income.