Should Lenders Collect Monthly Payments?

This is a pretty controversial topic in the lending industry, whether you should or should not charge your borrowers monthly payments. I personally choose not to. I get a lot of heat from doing so. Let’s cover some of the the pros and the cons from charging monthly payments to your borrowers as a hard or private money lender.

Cons To Collecting Monthly Payments

First, let’s go over the cons. The first con that I can think of is actually collecting monthly payments. It’s a burden, especially when you’re small. There’s a lot of managerial overhead. For example, making sure that payments were made, making sure that if they are late that you charge late fees, all the accounting that’s involved with that, etc. When you’re just getting started and you’re dealing with all the intricacies of the business, it’s not a good place to spend your time.

Your time is better spent finding better borrowers, more borrowers, better investors and more investors. Ultimately, when you’re in this industry, those are the two things that scale your business and allow you to make more money. Obviously, that’s why we’re all here — to make more money.

In my opinion, if you’re just busy doing little things in your business, it’s the wrong thing to focus on. Focus on what really moves the needle in your business and don’t just feel satisfied with being busy. If that’s the case, you’re not really scaling or growing.

Another con with collecting monthly payments is it puts a strain on on your borrower. The reason that people come to you in the first place is because they need money. I’m not saying to give bad loans, faulty loans or high risk loans where the borrower doesn’t bring any cash to the table. The reason they’re coming to you in the first place is they need funds. When you collect monthly payments, it puts an additional strain on the borrower when sometimes projects just don’t go well.

Let’s say you’re the borrower and you have a sewer line that you have to replace. In my opinion, when you’re paying these monthly payments, it really can affect the project adversely, and that’s the last thing we want.

We want our borrower to be successful and profitable so that we can be successful and profitable.

Another con that I think of is higher default risk. When you’re collecting monthly payments, it puts more strain on your borrower and, in turn, makes it a higher risk for default. That is the last thing we want. The reason that we’re in the lending business in the first place is because we don’t really want to deal with the properties. Obviously, there are those circumstances where we have to go into foreclosure and we have to take the property back. Then, we figure out what to do from there. The thing is, I don’t want the property, I really don’t. I want the passiveness.

I want the borrower to be successful and I also want them to make money so that they keep coming back to us and we have a good relationship. That way, they can grow and we can grow as well. I don’t want to put the the borrower in a situation where they can lose right off the bat. Again, there are ways that you can mitigate this. You can cut back on the risk by making sure that they have sufficient cash funds and reserves. I don’t want to set the borrower up to fail from the start.

Another con that I see is it increases the complexity of the loan servicing. We kind of already covered this, but basically it adds additional complexity to collect the payments, deal with the late payments, and deal with the accounting. On top of that, sometimes it can actually increase your operational costs as well. If you have a third party CPA or controller who’s trying to manage all this, your bookkeeping costs can actually be higher. Again, when you’re trying to grow or scale this lending company, that’s the last thing you need. K.I.S.S. – Keep It Simple Stupid. That’s really what we want to do. We want to make sure that we can continue to grow and build this company.

I’m a big fan of choosing a system, sticking with it and not introducing additional complexities. I see a lot of lenders who will give someone a 10% interest rate, but give someone else a 14% interest rate. After that, they will give another person a 21% interest rate because it is a high risk. We don’t want to deal with all that. In my company, we charge three points and 14%. That is straight across the board. We don’t negotiate on points or terms. This is what we do and if you don’t like it, you can go somewhere else. I’m okay with that. I realize that I’m not the cheapest by any stretch of the imagination.

We want to make sure that we don’t collect payments from borrowers because it kind of ruins our systems. Unless you have those systems in place, you can’t scale.

Pros To Collecting Monthly Payments

Obviously the biggest pro is to have a steady flow of cash coming into our business as a lender. On top of that, we also get to take those payments and we give them to the investors, so they’re getting a steady flow of cash. If you’re getting a paycheck every single month, that’s great right? That’s what everybody wants because it lets the investor know that they’re important to us. They’re getting a paycheck every single month and the project is progressing how it should. That’s great. So it helps our investor relations. It’s also nice to get a paycheck on a regular basis every single month.

Obviously, another pro for the lender is it reduces your risk because you’re collecting interest payments every single month. This way, the lender is still getting compensated. Let’s say after 3 or 4 months, the project starts to go downhill. Well, you’ve already collected 3 or 4 months of interest payment so you reduce your exposure by having some cash already collected on that project.

Another pro that I see is it keeps the borrower accountable. If they have to make monthly payment obligations to you, it keeps them on track. It keeps your project as a priority as well. If they know they have to pay you interest payments month after month, you’re more likely to have that project go smoothly. This gives the borrower more of an incentive to get the project done. When they see this money going out, they really understand how important it is to get that project done.

If you don’t collect monthly payments, you kind of get pressed to the background. The borrower won’t be in as big of a hurry to pay you off if they know they don’t have to write you checks every month.

One last point that I want to cover is collecting monthly payments definitely helps early project detection. Basically, if a project is going to fail, you will know. Let’s say you have a borrower and they’ve made payments for the first three months. Then, on month four, they miss their payment. Most likely, there is something going wrong with that project and it lets you jump in there and quickly be able to work with the borrower and resolve the issue.

On top of that, the same thing happens if you have a reserve fund for draws. Say you have a $30,000 renovation budget on this project and the borrower hasn’t taken out any draws. That’s not normal. It’s a quick red flag to ask yourself what the problem is with the project.

Why I Don’t Collect Monthly Payments

Let’s talk about why I personally choose not to collect monthly payments from my borrowers.

First and foremost, it’s an accounting headache. I just don’t want to deal with it. Like I said before, I want to have systems and processes that help me grow and scale. I don’t want to deal with all the additional complexities that are causing me to work in my business and not on my business. My main focus is growing my borrower base and growing my investor base. If I can get those to continually grow and scale, then I make more money, which is a win-win. I don’t want to focus on just the internal systems and processes. It’s not where my time is used most effectively, so I don’t collect monthly payments for that reason.

Before I was a lender, I was a house flipper. I flipped over 75 homes with the help of my team. Most of the time, we would work with lenders who did not require monthly payments. We would have a lot of projects going on simultaneously. We would have six, seven, sometimes even ten projects going on at once. If I was paying monthly payments, I could have been paying $40,000 per month in payments to my lender just because of the monthly payments on all of the different projects. It’s very common in this industry to not have cash and just be tight on cash. Again, the reason why people come to you to borrow is because they don’t have a lot of funds themselves.

Again, that’s not to say we want to do risky loans, but those loans are just an extra thing to keep track of. I really liked it when I didn’t have to make monthly payments to my lender. All of the interest payments just got paid at closing when the property got paid off or refinanced.

When lenders hear me say this, often times they ask me about my investors and if I am obligated to give them a monthly dividend. And in most cases, yes, you do. I set up my fund in a way that I don’t actually have to do that. It all comes from just setting investor expectations upfront. When we take on a new capital investor, I tell them that our debt fund is set up in such a way that our borrowers only pay us interest at the completion of a project. A lot of them get that because they understand it is a short-term project. Once it pays off, we both get our respective interests. I tell investors that they’re not going to get monthly payments, but that we are going to stagger them through multiple projects.

Say an investor comes in and brings me $100,000. The investor will get spread across 4 or 5 different projects so that these projects kind of stagger intuitively. This way, even though it’s not really monthly payments on the dot every single month, they might have a project that pays off within three weeks. They might also have another one that pays off six weeks later. Then, they have another one that pays off in eight weeks. This way, they’re not going the full six month term without receiving any payments, because I wouldn’t like that either.

As an investor, you want to feel like you’re making progress and collecting funds. That’s how we choose to do it. We just set the expectations up front and tell them that they’re going to get payments, but it’s not going to be on a set, regular schedule. That would put the business in a bind. I also don’t want to have all of these obligations to these investors and be strapped for cash flow. That’s not the kind of business that I want to run. I understand if investors don’t want to work with us because of that, but we just don’t choose to work that way. Thus far, it hasn’t been a problem with our investors as long as we set those expectations up front.

Hopefully you learned a thing or two. Again, I would love to hear from you. Whether you do or don’t choose to charge your borrowers monthly payments, let me know! I ask this just because I like to see the different perspectives and see what different people are doing.