What Is Private Credit and How Does It Work?

Private credit is lending to businesses by non-bank investors, such as private credit funds and business development companies, instead of through banks or public bond markets. The loans are negotiated directly, usually pay floating rates and are rarely traded. Investors aim for higher income than public debt, accepting less liquidity, less transparency and borrower default risk.

You keep seeing private credit in financial news and in fund marketing, often described as the asset class institutions have used for years and are now opening to individuals. Before you decide whether it belongs anywhere near your portfolio, it helps to know what is actually being bought: a loan to a company you probably cannot research yourself.

What counts as private credit?

Private credit means debt that is negotiated privately and not traded on a public market. A Federal Reserve FEDS Note on private credit defines it as debt-like, non-publicly traded instruments provided by non-bank entities, such as private credit funds or business development companies (BDCs), to fund private businesses.

The same note says these loans typically go to middle-market companies with annual revenue between $10 million and $1 billion, although lenders have increasingly funded larger companies that once borrowed through leveraged loans.

How does private credit work?

A lender and a borrower negotiate a loan directly, the lender holds it, and investors in the lending vehicle receive the interest.

Direct lending

The most common strategy is direct lending: one lender, or a small group in a "club deal," makes a loan to one company. The Fed note says direct lending loans are typically senior secured, meaning they are first in line to be repaid and backed by the company's assets.

Floating rates

Almost all private credit loans are floating rate, according to the Fed. The rate is a spread over a benchmark such as SOFR, so interest income rises and falls with short-term rates.

Held to maturity

Because there is no liquid secondary market for most of these loans, lenders typically hold them until they mature or are refinanced. The Fed found average maturities of around five years.

Other strategies

Beyond senior direct lending, private credit includes junior and hybrid loans, distressed debt, and asset-based lending against receivables, equipment or inventory. Each sits in a different place in the borrower's capital structure, with different risk.

How big is the private credit market?

Private credit has grown into a market roughly the size of the leveraged loan and high-yield bond markets. Using Preqin data as of June 2023, the Fed note put total private credit at nearly $1.7 trillion, compared with roughly $1.4 trillion of leveraged loans and about $1.3 trillion of high-yield bonds. Direct lending made up about $800 billion of that total.

The same note found the market is concentrated, with a handful of very large managers holding a large share of assets and uninvested commitments.

Who invests in private credit and why?

Institutions dominate, but individuals are a meaningful slice. The Fed note, citing Form PF data as of late 2021, said pension funds held about 31% of private credit fund assets, other private funds about 14%, and insurance companies and individual investors about 9% each.

Investors are drawn by income and by returns that, over the past decade, have exceeded comparable asset classes. The Fed attributes part of that to borrowers paying a premium for speed, certainty and custom terms, and part to lending to more highly leveraged companies that banks will not fully fund. Higher yield is compensation for higher risk, not a free extra.

How can individuals get exposure?

Individuals usually reach private credit through a pooled vehicle rather than by making loans themselves.

Vehicle	Typical access	Liquidity
Publicly traded BDC	Anyone with a brokerage account	Trades on an exchange; price can swing
Non-traded BDC or interval fund	Often income or net worth minimums	Limited, periodic redemptions
Private credit fund (private placement)	Usually accredited investors only	Lockups; little or no early exit

Private funds are typically sold as private placements, which means less disclosure than a registered fund and a heavier due diligence burden on you.

What are the risks of private credit?

The main risks are default, illiquidity, valuation and concentration, and they can show up together in a downturn.

Default risk

Borrowers can fail to pay. The Fed noted that average interest coverage among private credit borrowers had fallen to around 2.0x, lower than leveraged loan borrowers at about 2.7x, which leaves less cushion if earnings drop.

Liquidity risk

You may not be able to get your money back when you want it. Funds can limit or suspend redemptions. Our guide to liquidity risk explains how this plays out.

Valuation risk

With no market price, loans are valued by models and manager judgment. Reported values can lag reality.

Rate and concentration risk

Floating rates raise borrowers' costs when rates climb, which can strain weaker companies. A fund with a few large loans, or loans to one industry, carries more single-borrower risk.

Questions to ask before investing

Use these to compare any private credit offering:

What share of the portfolio is senior secured, and what is junior or hybrid?
How many borrowers are there, and what is the largest single exposure?
How are loans valued, how often, and by whom?
What are the redemption terms, and has the fund ever limited withdrawals?
What are all the fees, including performance fees?
What happened to defaults and recoveries in past stressed periods?

Frequently asked questions

Is private credit the same as private equity?

No. Private equity buys ownership stakes in companies. Private credit lends to companies and gets paid interest, usually ranking ahead of equity holders if the borrower fails.

Is private credit safer than stocks?

Not in a simple sense. Senior secured loans rank ahead of equity, but private credit adds illiquidity and valuation risk that listed stocks do not have, and borrowers are often highly leveraged.

Why do private credit loans pay more than bank loans?

According to the Federal Reserve, borrowers pay a premium for speed, flexibility and custom terms, and many are riskier companies that cannot get enough bank funding. Lenders also want extra pay for holding loans they cannot easily sell.

Can non-accredited investors buy private credit?

Some can, through publicly traded BDCs or certain registered funds. Most private credit funds sold as private placements are limited to accredited investors.