Traditional lending is going to a bank and getting a mortgage where you simply pay principal and interest each period based on an interest rate, total term, and payments per year or getting an auto loan with regular p+i repayments over 5 to 7 years. However, there are some alternative lending options that have come up over the years so let's get into it.
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Alternative lending refers to non-traditional ways of borrowing and lending money, often facilitated by technology platforms that connect borrowers with investors or lenders. Some types of alternative lending include:
- Peer-to-peer (P2P) lending: P2P platforms connect individual investors with borrowers looking for personal or business loans. Borrowers receive the loan from multiple investors, spreading the risk among lenders and the platform takes a fee of all the interest payments as well as potentially taking origination fees and late fees / penalties or splitting those with the individual lenders.
- Crowdfunding: Crowdfunding platforms allow entrepreneurs to raise funds from a large number of individuals, often in exchange for a product, service, or equity in the business. You see this in video games a lot.
- Invoice financing: This type of lending involves a company selling its outstanding invoices to a lender at a discounted rate to receive immediate cash flow. I've seen P2P lending platforms facilitate this activity between individuals lending to businesses and it works more like a credit facility with a utilized and unutilized interest rate that is based on invoices the business submits to be paid for by the platform. What can end up happening is the platform ends up being the bank because they are paying for invoices and then when the business is paid for invoices owed to them, that goes straight to repay the outstanding invoices. It can get really sticky if the platform doesn't have good code to handle this.
- Merchant cash advance: This involves a lender advancing funds to a business in exchange for a percentage of future credit card sales.
- Online lending: Online lenders use digital platforms to offer loans to consumers and small businesses, often with faster approval times and more flexible lending criteria than traditional banks.
- Microfinance: This involves lending small amounts of money to people with limited access to traditional banking services, often in developing countries.
- Revenue-based financing: In this type of lending, a lender provides funding to a business in exchange for a percentage of its future revenue. I've seen this by a few clients of mine in the past. It is pretty straight forward and usually has some cap to the total repaid.
