Buying debt is a type of financial strategy in which you purchase a debt instrument and earn profits by interest payments or an increase in the principal amount paid at redemption. There are several different types of debt instruments that may serve as investments, including bonds, accounts receivables, real estate, and mortgages. Whenever you evaluate a potential debt investment, it is important to verify the quality of the debt to make sure that you are making a sound investment.
Buying Fixed-Income Securities
- Determine what type of bond to buy. There are a variety of different bonds that you can acquire as an investment, including U.S. Treasury Bonds, municipal bonds and corporate bonds. Bonds are debt securities, which means that you are lending money to the bond issuer (government or corporation) and they promise to pay you back with interest over a certain period of time.
- Purchase U.S. Treasury Securities. U.S. Treasury bonds are the safest bonds in which to invest since the U.S. Government backs them. There are a variety of treasury bonds that you can purchase directly from the U.S. treasury at http://www.treasurydirect.gov. These include Treasury bills (T-bills), which are non-interest paying and short-term (1-year or less), notes, which have terms up to ten years and pay interest semiannually, and bonds, which have terms over 10 years.
- Treasury bonds mature in 30 years, which means it will take 30 years to reach the full, face value of the bond. You receive interest payments every six months with these bonds.
- I Savings Bonds are purchased at face value and you earn interest over the life of the bond. These are low risk savings bonds.
- EE and E Savings Bonds are purchased at face value and pay interest based on current market rates for up to 30 years.
- You can also purchase savings bonds from local banks or through brokers, however, you will be required to pay a fee in addition to the amount of the initial bond investment. It makes more financial sense to purchase your treasury bonds directly from the U.S. Treasury and save yourself the additional costs.
- Find a securities broker. A securities broker is licensed and registered to buy and sell securities. There are a variety of brokers, including: full-service, who help clients with various investment needs; discount brokers, who buy and sell bonds for clients but do not give investment advice; and online brokerages, which provide full-service investment advice and investment via the internet. When choosing a broker, consider the following:
- Is the broker experienced, credentialed and registered with the Securities and Exchange Commission? You should ask the broker for their credentials and discuss their experience in the industry.
- Be sure that the broker has access to the bonds you want. If you want to invest in municipal bonds, determine whether the broker handles those types of bonds.
- When speaking with a potential broker, ask for a full list of their fees and compare those with other brokerages.
- For a list of top-rated online brokers that trade bonds, visit: http://www.kiplinger.com/article/investing/T052-C000-S002-best-online-brokers-2014.html.
- Purchase municipal bonds. Interest paid from municipal bonds is exempt from federal income taxes. These bonds may offer a better investment than bonds with a higher rate of return if you are in the highest federal income tax bracket of 35%. You can own municipal bonds through municipal-bond unit trusts, through mutual funds, or individually.
- Check the bond rating before buying any fixed income security as lower-rated bonds have higher risks of default. Anything lower than a BBB rating (BB, BA, CCC etc.) is a risky investment. You can view bond ratings at: https://www.moodys.com/page/lookuparating.aspx.
- Administrators or investment advisors manage municipal-bond unit trusts and mutual funds. If you purchase bonds through these agents, they will take your financial investment and spread it across a variety of bonds. This reduces your risk through diversification. You are typically charged a percentage of your initial investment as a sales commission.
- Individual bonds are purchased through a bond broker and the commission or fee is included in the price that you pay for the bond. By purchasing an individual bond, you are not able to spread out your risk.
- Invest in corporate bonds. Corporate bonds are issued by corporations and typically pay higher rates of return than treasury or municipal bonds. Typically, the bond holder will receive periodic interest payments until the bond reaches maturity. The interest income generated by these bonds is taxable.
- Just as with municipal bonds, you should check the bond’s rating to make sure that you are making a sound investment.
- Purchasing your bonds through a mutual fund reduces the overall risk to your investment. Mutual funds are able to diversify your investment portfolio much more so than a person investing in individual corporate bonds.
- Consider bond mutual funds or bond ETFs. Bond mutual funds and bond ETFs allow you to invest many — sometimes hundreds — of bonds. However, unlike individual bonds, bond mutual funds and ETFs can potentially decrease in value, as the underlying bonds can be sold before they mature. On the other hand there is also more potential for you to receive greater gains when you invest in this way.
Financing Private Lending
- Provide a direct loan. Another type of debt investment is to provide financing for a purchaser to buy an asset, such as property that you own. Private lending agreements can be made for any type of asset purchase. These loans are typically backed by the borrower's assets, giving the lender the right to seize those assets in the event that they default. These loans can be taken out by businesses or by individuals.
- For buyers that have difficulty obtaining a traditional mortgage, private lending may provide them the only opportunity for home ownership. As the seller, you can retain the deed until certain conditions are met and receive a steady cash flow while the buyer meets his or her obligations.
- Provide a loan application. Once you have located a potential borrower, be sure that the buyer completes a detailed loan application. You should verify that all of the information provided is correct and run a credit check on the potential buyer.
- For mortgage loans, you can download a Uniform Mortgage Loan application at: http://www.freddiemac.com/uniform/pdf/form65.pdf.
- Negotiate the terms of the loan. You should check local or market interest rates when determining the rate at which you plan to finance the loan. Keep in mind that secured loans often offer a lower interest rate because the lender is protected by their right to seize the borrower's property in the event of a default.
- Draft a loan agreement. You may want to consider hiring an attorney to draft the loan agreement for you. If you choose to draft the agreement yourself, make sure that you comply with all state laws. You can search your state’s laws at: https://www.law.cornell.edu/statutes.html. Generally, your agreement should include:
- The loan amount, the date that payments are due, the length of the contract, signatures of all of the parties, and the amount of the down payment (if you are lending for a mortgage).
- You should specify that the secured asset is held as collateral for the loan and that you can seize that asset if the buyer fails to meet his or her obligations.
- For a mortgage loan, you can consider requiring a balloon payment. Rather than financing the property over 30 years, you can require that the seller make a significant payment at the end of a fixed period. This is referred to as a balloon payment. By that time, the seller should qualify for a traditional mortgage and be able to pay off their debt to you.
Purchasing Accounts Receivables from Other Companies
- Start a factoring company. If you plan to purchase debt as a business venture, it may be best to start your own factoring business, or accounts receivables financing company.
Factors are businesses that buy companies’ accounts receivable at a discounted rate (the money owed to a company by its debtors) and attempt to collect the debt for a profit. They are sought out by companies that need additional cash flow in order to maintain their business.
- A factoring company purchases a company's accounts receivable for a discount of the amount owed. It makes profits by collecting interest on the outstanding balances of the accounts purchased as well as the difference between the discounted value and the amount collected.
- Attend training workshops. If you are new to the factoring business, you may want to attend factoring training workshops run by those in the factoring profession. These workshops may provide you with critical skills to run your business successfully. You can locate these training sessions by conducting an internet search for “factoring training courses.”
- Advertise your factoring business. Once you have established your factoring business, it is important that you locate clients. You can do this by advertising your business, which includes using social media.
- You may also want to consider joining a factoring business association, which may provide you with networking opportunities.
- Evaluate a potential client’s accounts receivables. Businesses that need an inflow of cash will look to factoring business to purchase their accounts receivable. Once you have identified a potential client, you should evaluate their accounts receivable. In order to determine whether the debt is a sound investment, consider the following:
- Determine whether their invoices are easily collectable. In order for this to be a good investment, you must be able to collect on the outstanding invoices. Review the accounts receivable and evaluate whether the individuals or businesses have the resources to pay off their debts.
- Determine whether the assets of the debtor are already encumbered. If the accounts receivable is full of businesses or individuals with liens or claims against their assets, it may not be a sound investment. You can determine whether assets are subject to any liens or claims (also referred to as an “encumbered asset”) by conducting a public records search.
- Determine whether the potential client has properly managed their accounts receivable. It is important to be able to easily take over and manage the accounts receivable. If the client has not properly maintained their database, it may be difficult to collect on the debts.
- Buy the accounts receivable. Once you have determined that a company’s accounts receivable are collectable and appear to be a sound investment, you can make an offer to purchase the company’s accounts receivable.
- Typically, a finance company would purchase a business’ accounts receivable in two installments. The first usually covers 70 to 90% of the gross value of the outstanding invoices.
- The second payment, for the remainder of the gross value minus financing fees, is made when the customers pay their invoices in full. Financing fees are generally between 1.5 and 3.5 percent per 30 days and depend on a variety of factors including your industry and customer creditworthiness.
- A factoring business buys the accounts receivable at a discount and charges a fee for collecting on the invoices. This allows the factor to make a profit on the purchase of the accounts receivables.
- Consider offering account receivable financing. In contrast to factoring, accounts receivable financing allows the borrower to take out a loan against the value of their accounts receivable. In other words, the borrower pays back the lender directly, like in a normal loan, rather than signing over the rights to collect on their accounts. This reduces risk for the lender because they don't have to worry about collecting on unpaid accounts. Consider this as a less-risky alternative to offering factoring.
- Keep in mind that this lower risk also generally translates into lower interest rates paid to you as the lender.
- Those who are new to investing in debt should take the time to learn how profit is made from different types of debt instruments and spend some time running a few trial investments before actually making a purchase. Doing so will make it easier to know what questions to ask brokers and how to understand their responses.
- Buying debt is an investment activity. Make it a point to not invest more than you can afford to lose and still maintain your lifestyle. Avoid pulling money from the household budget since a loss could mean an inability to pay for essential expenses like the mortgage or car payment.
- Cancel a Contract for a Deed
- Invest in Bonds
- Invest Small Amounts of Money Wisely
- Buy Bankruptcy Foreclosures
Sources and Citations
- ↑ http://www.nolo.com/legal-encyclopedia/seller-financing-home-sales-30164.html
- ↑ http://www.continuouscashflow.net/CCF_Factoring_Basics.pdf