How to Start a Personal Loan Business

Starting your own business to provide personal loans can be lucrative if you go about it in the right way. It can also be challenging, especially given the many regulations you’ll have to be aware of and follow. Here are some of the basics you need to know.

Funding a Personal Loan Business

There are many ways to get started in a personal loan business, but all require that you amass enough capital to begin making loans. That capital can come from a number of different sources, including:

• Your own money. If you’re lending your own money, you get to keep all of the interest that’s paid on the loan and can charge what fees you wish, as long as you stay in compliance with the law.
• Investor money. With this type of lending business, investors provide you with the funds to make loans, so that it isn’t only your money at risk. The investors might receive all or part of the interest from the payments, while you’re compensated in the form of origination fees and other charges.
• Peer-to-peer (P2P) lending. Rather than directly lending money, you provide the means to connect individual borrowers and lenders. You might do it through an app or a website. You take a cut of the deal but aren’t putting up your own money or that of investors.

However you choose to fund your business, you’ll need to consider the fact that some borrowers may miss payments or default on the loan, costing you or any other lenders money.

Pros and Cons of a Personal Loan Business

While running a personal loan business can be more profitable than some other types of small businesses, it can also be subject to more rigorous regulations.

That can include the types of licenses you’ll need, how much you can legally charge, and how you can go about collecting the money you are owed.

These are some of the pros and cons to consider:

Steps in Starting a Personal Loan Business

In some respects, launching a personal loan business can be like starting any other business. The necessary steps include:

Develop a Business Plan

First, 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 money unless you can show them a good business plan. Even if you’re going it alone, a business plan can help you think through how your business will run.

A business plan should typically 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 appear at the beginning of your plan.
• Business summary. Describe your business in this section. Offer an overview of your goals and what you hope to accomplish. Any key people in your company should be recognized here, along with their skills and what they can contribute to the success of your business.
• Products. Make sure you’re clear about the types of loans you plan to 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 indicate whether you plan to provide options such as allowing co-signers and whether your loans will be secured, unsecured, or some combination.
• Market analysis. Next, you need to provide an analysis of your target market and potential demand. You’ll want to back this up with research and describe the level of growth you can reasonably expect, in addition to any potential challenges.
• Competitive analysis.Take a look at your likely competitors in the space. Compare their strengths and weaknesses to your own, provide an overview of how your business fits in and any advantages it might have.
• Marketing plan. Your marketing plan should address such questions as: How will you reach your target market? What channels will you use, and do you have any special promotional strategies in mind?
• Operations plan. This section is all about logistics. Where will you be located? Will you have offices or operate entirely online? Do you have special equipment or people who can be used to make this business a success?
• Financial plan. Lay out the numbers. Try to project your startup costs and the amount of investment you’ll need. Provide profit and loss estimates and detail your expected cash flow. Aim to look ahead three to five years.
• Appendix. If you have any supplementary materials and documentation, they should go in this section of your plan.

Form a Legal Entity

Once you have your business plan nailed down, you need to form a legal entity. Decide whether you should start out as a sole proprietor, form a partnership with additional owners, or create a limited liability company (LLC) or corporation. Which structure you choose can affect how your businesses is taxed and how much personal liability you will be exposed to.

An accountant or a business attorney can help you figure out which type of structure makes sense for you, and you can change it in the future as your business evolves. You call also find basic information on these different business structures on the U.S. Small Business Administration website.

Depending on your business structure and the state where you’ll be operating, you may need to file articles of organization and register your business with the appropriate state, county, and city offices.

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.

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. Different states, counties, and cities can have their own rules. You should be able to find much of the information you need on the Nationwide Multistate Licensing System (NMLS) website.

Set Up Your Accounting System

You’ll want to keep your business activities strictly separate from your personal finances. At a minimum you’ll need a system to keep track of when your borrowers make their payments and how much of each payment should go toward the principal and how much toward interest. If you have any employees, you’ll need a system to handle payroll. And, if you have investors, you’ll need to make sure that they’re paid what they’re due.

You can hire an outside accountant to handle these matters or try to do it yourself with accounting software.

Get Business Insurance

Having the right business insurance can protect you from a variety of different financial hazards, and certain types of policies are required by law. For example, the federal government requires that any business with employees have workers’ compensation insurance, unemployment insurance, and disability insurance.

Other common types of business insurance include general liability, product liability, and professional liability.

What Else to Expect When Starting 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. As mentioned, it’s also important to make sure you have enough available capital and understand all the relevant federal, state, and local regulatory requirements. For example, some states put caps on the interest you can charge on loans, so you’ll want to set your annual percentage rates (APRs) (which include both interest and origination and other fees) accordingly.

To protect your business, you’ll want to decide how you intend to vet loan applicants, such as running credit checks, and determine the minimum credit score you’ll accept.

You’ll also need to set up a system to collect payments from your borrowers. This can take the form of an online portal, mail-in payments. or other arrangements. If you plan to automatically deduct payments from borrowers’ bank accounts, you’ll need to obtain the appropriate permissions. Because some borrowers may fall behind in their payments, you’ll need to establish a collections policy for delinquent loans. Again this will have to be done in accordance with local laws.

Additionally, you’ll want to take precautions in handling borrowers’ sensitive personal information, such as their Social Security numbers (SSNs), bank account numbers, and so forth.

The Bottom Line

A personal loan business can be profitable and relatively easy to manage once you have a good system in place. However, it also calls for a significant amount of upfront capital and requires paying close attention to the many laws that regulate such businesses.

This article represents general guidance on setting up a personal lending business. Federal, state, and local regulations affect how a personal loan business works in each location, and you should check requirements before starting a new lending business. Consider working with an attorney or other professional to navigate the extensive regulation in the financial services industry.