What is Alternative Lending?

Individuals and small businesses alike may need funding to improve some aspect of life or work. Many times, they feel that they’re at a disadvantage when seeking financial help from a traditional bank. Fortunately, alternative lending exists for this very reason. It has become a popular option for those who seek to borrow in a way that closely fits their needs.

What Is Alternative Lending?

Alternative lending or marketplace lending is a type of lending process that does not rely on traditional banks. Instead, lending takes place as a peer-to-peer (P2P) transaction. Online lending platforms conduct these loans. Alternative lending is a lending industry that is completely different from the traditional lenders, such as banks and mortgage companies. Most of the time, alternative lending is ideal for individuals who are not deemed lending candidates by traditional banks. The process of lending between peers tends to be less complicated than standard lending practices. It is an industry that gives people access to funds and financing options in ways that are not possible through the traditional means, greatly helping small businesses and projects manage their cash flow. Alternative lending includes many different types of lending products, but all of them have one thing in common: they allow you to use your assets to secure a loan and make a profit while you use the loan to grow your wealth. This can be done by taking out a line of credit or purchasing an investment property. This greatly benefits small businesses, students, and others who need something beyond standard loans.

Types of Alternative Lending

Alternative lending has introduced new lending sub-types that benefit small businesses and individuals. This type of lending offers a variety of financing options that traditional banks do not. While there is an array of diverse lending options, some of the most common forms of alternative financing options are as follows:

Direct Lending

One common type of alternative to traditional bank financing is direct lending. Put simply, instead of the bank loaning money to an individual, the individual will go to a lending platform and receive funds directly from non-bank lenders. Direct lenders include many kinds of nonbank lenders such as peer-to-peer lenders, online lenders, or marketplace lenders. These alternative business lenders will usually provide a loan that can be used for various purposes. These may include buying a house, starting a business, or other ventures that are not viable through traditional banking options.

Venture Debt

Another one of common alternative funding options is the venture debt. This option is offered by private equity firms, hedge funds, and business development companies. The primary benefit of a venture debt is that it can be taken out in order to improve the growth of a business or new project. It can also be used to purchase equipment and other necessary items for the company. This type of lending is useful for individuals who are interested in starting their own business, improving their current work, or investing in new ventures.

Mezzanine Financing

Mezzanine financing is an alternative lending product that is used to bridge the gap between debt and equity financing. It is also a form of alternative lending that can be used to help companies raise funds through private investors or outside lenders. It works almost like stock rather than the typical debt. Borrowers can also convert mezzanine funds into stock depending on their specific deal.

Lines of Credit

Lines of credit are specific sums of money that a lender offers a borrower, much like lines of credit from a bank. Borrowers can draw from their line of credit under and up to the fixed sum they’re approved for. In turn, they repay the sum with interest added on.

Short-term Loans

Short-term lenders typically expect repayment within a year’s time. They’re virtually unheard of with traditional banks and can be very useful for a small business that seeks quick money to cover sudden costs.

Installment Loans

Installment loans are a lump sum loan that the borrower repays at regular intervals until the sum has been paid in full. Typically, borrowers pay back the loan in a fixed monthly fee, with little to no rate fluctuation throughout the life of the loan.

Merchant Cash Advances

This type of loan is ideal for small businesses that need quick cash. In exchange for future credit card sales, merchant cash advance lenders offer borrowers a sum of money. Borrowers must pay the sum back with a portion of the company’s credit card revenue.

Microloans

Microloans are low-value loans of typically less than $50,000. Because traditional banks lend large sums of money, alternative lenders carved out a niche by offering smaller loans. For individuals and businesses that do not want to invest in expensive loans they don’t need, microloans are a great solution. Repayment terms for microloans tend to be much shorter than standard lending terms as well.

Equipment Financing

These loans help small businesses that need equipment to keep the company in operation. This type of lending offers businesses a way to overcome the expense of new equipment. The equipment becomes collateral and because of this, payback rates are lower than standard lending.

Alternative Lending Pros and Cons

There are benefits and risks associated with alternative lending that borrowers need to consider.

The Pros

Here are some of the advantages of dipping into alternative lending options: 1. Simple Application Process

The requirements for an alternative loan are often much less stringent than for a traditional bank loan. Knowing the inherent risk of lending funds to these businesses means that traditional and community banks have extremely strict eligibility requirements. As such, it may be more fruitful for smaller businesses to look to alternative lending. They may have more flexible requirements, such as relating to the credit score or credit history, as well as the annual revenue of you and your business. Technologies allow borrowers to receive the funds they need. This speeds up the process so that it takes less time than a standard loan. In many cases, it takes only a single day for application and approval in an alternative lending route. 2. Wide Variety of Options Compared to the traditional lender, alternative lenders are also able to provide a wider variety of loan options so that borrowers are more able to seek out products that closely fit their needs. This is great news for small businesses and entrepreneurs who do not have the same access to capital as other businesses. Be it through commercial financing, venture debt, or other types of loans, alternative lending allows you to tap into new sources of funding that you may not have been able to access before. 3. Greater Approval Rate Additionally, alternative lending sees much higher approval rates than traditional lending practices. Alternative lenders approve over half of applicants for funding. By comparison, only roughly 50% of traditional lending applications, such as loans lent from traditional banking institutions, get approval. This is because the banking industry tend to view smaller or early-stage businesses as a bigger financial risk compared to large, established companies.

The Cons

Of course, you should also take note of the possible disadvantages of alternative lending. Here are some of them: 1. Higher Interest Rates Because they do not have very strict requirements and have shorter terms, interest rates through alternative lenders tend to be higher than conventional lenders. This is due to the fact that alternative lenders need to minimize their lending risks. 2. Smaller-Sized Loans Alternative lenders usually offer smaller loans with shorter repayment terms. This means that they expect repayment sooner than traditional banks do. 3. Less Guaranteed Reputation Traditional banks have established reputations for themselves as credible lenders. It may not be the same story when it comes to alternative lenders. One alternative lender is not the same as the next, so it’s important for borrowers to practice due diligence.

Final Thoughts

Alternative lending is not ideal for every situation. However, it connects borrowers with lenders who provide a wider array of services than traditional banks. The market for alternative lending is rapidly growing, and the number of new businesses offering loans through online platforms is increasing. Alternative lending options can be very useful to small businesses and individuals who need funds to finance a project or take on a new venture. It is also a viable option for those who are not qualified for traditional bank loans. For example, it may be more beneficial to borrow from an alternative lender if you have an unstable credit history or a bad credit score. It’s still important to research and weigh options before making big financial decisions. Regardless, alternative lending may very well be the option that best fits a specific financial need.