Alternative Lending & Micro Lending: How Does this Work for your Finances?
Updated: Feb 26, 2022
The world is full of ways to invest. It used to be that lending to other people isn’t one of them, unless you are a bank but that’s not true anymore. There’s alternative lending, micro lending and peer to peer lending.
How does traditional lending work?
Traditional lending works much like a stock market. Banks create deposits which they then lend out to borrowers. When the borrower pays off the debt, the lender gets his/her deposit back plus interest. If the borrower doesn't pay, he loses his deposit and may even lose his home if he's behind on his mortgage payment.
What is Alternative Lending?
Alternative lending refers to any loan that is secured outside of a traditional banking institution. The money comes from financial institutions that aren’t banks such as credit card companies, mortgage lenders, business lenders and crowd funding. Crowd funding has fully blossomed within the past 10 years.
In fact it was only in 2009 when crowdfunding first started gaining traction with the launch of Kickstarter. Since then there have been many more platforms like Indiegogo, GoFundMe, RocketHub, Wefunder, etc.
These sites allow individuals or businesses to raise funds for their projects by offering rewards or donations. They also offer loans which can range anywhere between $5K-$100M depending on your project.
Why would anyone want to get into alternative lending?
There are several reasons why people choose to go down the path of alternative lending:
• Lower Interest Rates - Most alternative lenders offer lower rates than conventional banking options. For instance, Prosper offers 2% APR while Bankrate charges 5%.
• No Credit Checks - Many alternative lenders don't require credit checks because they know that bad credit will prevent people from getting approved for a loan anyway.
• Flexible Terms - With alternative lending, you're free to set your own repayment schedule. Some companies allow you to repay as little as once per month!
• More Options - Alternative lenders often give you more flexibility than banks. For instance, you might be able to take advantage of zero percent intro rate periods or flexible monthly installments.
• Less Hassle - Because most alternative lenders aren't regulated by federal agencies, their processes tend to be less complicated than those of banks. Plus, you'll never need to deal with bank tellers again.
What is a Micro Loan?
A micro loan is an online or mobile based small dollar financing option for individuals who need short term cash flow assistance. These loans can be issued by a single individual or aggregated across a number of individuals who each contribute a portion of the total amount. Microloans are usually paid back over time through regular payments made by the borrower on their own terms.
Micro lending has been facilitated by the rise of the internet and the worldwide inter-connectivity that it brings. People who wish to put their savings to use by lending and those who seek to borrow can find each other online and transact.
The term micro comes from the loan size, but it’s not micro from the perspective of the person receiving it. You won’t hear of many $2 loans in the United States, where $2 wont buy you anything more than a chocolate bar. But in cities like Lagos, Nigeria and Nairobi, Kenya, $2 has the buying price of roughly $40 in the US. Because micro lenders lend out smaller amounts than traditional lenders, they don’t need large sums of capital to make investments. Instead they use technology to connect borrowers directly with investors. Some examples include Kiva Zip, Zidisha and Fundly.
Microfinance is not simply about smaller loans, the structure of the loans can be very different.
For example in solidarity lending, loans are made to groups rather than individuals are often used. Some micro financing institutions use sophisticated policies to guide their business, including the policies around how long people need to be regular savers before they can take out loans.
Frequently Asked Questions
What is Peer-to-Peer Lending?
Peer-to-peer lending is when individuals lend or borrow funds directly with each other without an intermediary like a broker. It can also include crowdfunding where investors fund projects through online platforms. P2P platforms have been around since at least 2005 when Prosper was founded by two Stanford students. In 2009, Zopa launched with £1 million. Today there are over 1,000 online peer-to-peer lending sites worldwide.
Is Peer-To-Peer Lending Right for Me?
If you've got decent savings already, then yes, peer-to-peer financing is right for you. It's easy to start small and build up your portfolio. The best part about peer-to-peer finance is that you can invest any amount you'd like. There are no minimum investment requirements so you can put just one dollar towards investing.
If you're looking for ways to earn extra money, consider starting a side hustle. Side hustles are low risk, high reward opportunities that let you generate income outside of your day job. You can find many different types of side hustles including blogging, freelancing, selling goods on Amazon FBA, drop shipping, consulting, coaching, speaking, writing, tutoring, etc. The key here is finding something you enjoy doing and making sure you love what you’re creating.
Once you figure out how to monetize your passion, you’ll always have plenty of ideas for new products to sell.
What Are My Investment Choices in Peer To Peer Financing?
When it comes to choosing investments in peer-to-peer lending, investors should look for quality assets. This means that the company has strong financials, solid management team, and good customer service. You also want to make sure that the asset class being invested in isn't too volatile. That way, you won't experience big swings in value during times of economic uncertainty.
In other words, you want an asset that provides steady growth over time without causing major fluctuations when things get tough financially.
How Do I Invest in Peer-To-Peering Finance?
Once you decide which type of peer-to-peer funding vehicle makes sense for you, there are two main paths you could follow. First, you could use online platforms such as LendUp or Zopa to connect directly with borrowers. Second, you could work through brokers who specialize in this area. Either option works fine but if you choose to go direct, you may save some money. Brokers charge fees ranging anywhere between 1% and 5%.
If you do business with them, you'll pay these upfront before receiving funds. In contrast, using online platforms typically costs nothing unless you receive payments. However, you'll still need to cover transaction fees.
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