Simply put, lending refers to the action of allowing an individual or organization the use of something (in this context, money) for a period of time, under an agreement to return or pay back later.
Lending is nearly as old as man, going as far back as prehistoric times. People would borrow what they needed such as seeds, crops, food, or animals and return the proceeds at a later date.
Lending is a phenomenon that has largely evolved, and today, there are countless financial institutions (private and public) that offer lending services to an ever-demanding market. The party who gives out money or assets as a loan is the “lender,” while the recipient party is the “borrower.”
These lending services typically come with extra costs for the borrower, known as “interest.” Interest may vary from one type of loan to the other, as well as the lender involved.
This piece will cover aspects of lending such as the types of lending, and types of lenders. However, it is also imperative to note that lending is undertaken to serve a wide range of purposes on the part of the borrower. These purposes are broadly categorized into two, and the first sub-segment in this piece will examine the differences which exist between the terms “consumer lending” and “business lending.”
Consumer Lending and Business Lending: The Divergence
As the name implies, consumer lending is the category of lending that caters to individual (personal) needs. In this category, the borrower needs the money to finance such things as a home mortgage, car/auto purchase, education, home equity, and household expenses. Many financial institutions and other creditors offer such lending services, usually to be repaid monthly with interest.
Business lending is the direct opposite. Loans in the business ending category are used to cater to corporate needs for businesses and organizations. Borrowers take loans to raise capitals for startups, or to sustain a running business. Business loans may come with larger limits and higher interest rates than consumer loans.
As a result of the complexities of business lending, there are fewer restrictions by the government on loans in that category. On the other hand, consumer loans are taken on a personal note; as a result, there are stronger legal boundaries in place to protect borrowers from discrepancies like discrimination.
Constitutional provisions like the Equal Credit Opportunity Act of 1974 and the Fair Housing Act of 1968 are still strictly binding in the U.S, prohibiting creditors from discriminating against loan applicants on basis of race, religion, color, nationality, gender, marital status and age.
The laws against discrimination by the Equal Opportunity Act are also binding on business lending, but more relaxed on internal affairs like duration of loans, and how the lender notifies the borrower of debt. The Fair Housing Act is more enforcing on both sides of the divide.
Types of Loans
It is safe to conclude that business loans and personal loans are the two broad categories of types of loans, but there are quite a number of loan types under these categories that are very different in nature and purpose, worth discussing.
However, the focus of this segment is business loans, and below are a few types of business loans:
- Working Capital Loans: These are taken to finance a business’s daily operations, especially if the business does not have stable revenue. Businesses whose services are in seasonal demand take working capital loans for when their revenue tanks. These types of loans are typically easy to get, especially for businesses with good credit.
- Commercial and Industrial Loans (C&Is): These are short-term loans taken by corporations to generate working capital or finance capital expenditures, and they typically require collateral. Collateral is provided by the business (borrower) in exchange for more flexible interest rates.
- SBA Loans: These are loans taken by small business owners to cater to corporate needs. This type of loan is peculiar as the Small Business Administration (SBA) in itself doesn’t act as a lender, but as a guarantor on behalf of the borrower to the lender. The SBA is a government institution that partially pays up the debt in the case of default by the borrower. In exchange, the SBA requires at least 20% ownership of the business as collateral.
- Equipment Financing Loans: These short-term loans are taken by businesses to generate capital to purchase machinery and equipment for commercial purposes. The equipment purchased acts as collateral for this type of loan.
- Business Mortgage Loans: Also known as commercial real estate loans, these are long-term loans taken to cover the costs of securing properties for business use. These loans are up to 20 years in duration, with amortization periods extending longer than that. Properties secured by these loans act as collateral.
- Credit Card Financing: Initially exclusive to personal lenders, credit card issuers now offer lending services to business owners as well. Credit card financing loans are used to generate capital for small-scale startups using a credit card. They are usually short term and with a high interest rate.
- Vendor Financing: This type of loan is also known as trade credit, and it involves the lending of money by a vendor to a customer who uses the loan to buy the vendor’s product or service. These types of loans come at higher interest rates to compensate the vendor for the increased risk of default.
Loans are taken by businesses typically are usually for at least one of the following purposes:
- To generate capital for startup
- To generate funds for operations
- To finance disaster recovery.
As a borrower, the following factors are important to consider while searching for the best loan services for your business:
- Loan Purpose: The reason for your loan will guide you to the best service available to you. Whether to start a new business, to grow an existing or to avert the danger of bankruptcy for your business, ensure that you have the purpose of your loan mapped out before you proceed.
- Loan Amount: With your loan purpose highlighted, it is important that you know exactly how much you need. Loan services can be very tempting at the point of agreement, but if you take more than you need, or than you can repay, you put your business at risk of multiple debt and bad credit. Determine how much you need to cater for your loan purpose and take just that.
- Loan Duration: Choose a time frame that will not strain your business. This will help streamline the type of loan services you can choose from. Ensure that you bear interest rates in mind as well.
- Loan Collateral: This is not entirely up to the borrower, but it can be a guide. For loans like equipment financing or mortgage, the lender will only accept purchased machinery or property. If these types do not suit your convenience, other types of loans will.
Types of Lenders
As earlier mentioned, lending has evolved into a lucrative industry, owing to the infusion of diverse lenders, from conventional banks, credit unions and other financial institutions to unconventional ones as will be examined in this segment. In this category are lenders like crowd funders, peer-to-peer (P2P) lenders, family and friends, yourself
Crowdfunding is the action of funding a project by collecting small amounts of money from a large number of people to make a whole sum. Crowdfunders are sourced via social media and other platforms and crowdfunding is statistically proven effective in raising billions of dollars worldwide. Crowdfunding is raised in exchange for rewards for contributors, usually from the project funded. Several crowdfunding platforms like Kickstarter, GoFundMe and a host of others exist and are used to fund an array of projects daily.
This category of lenders are similar to crowd funders in that they are connected via digital platforms to potential borrowers, but the lenders get their money back in full, unlike crowd funders who may not. Loans from P2P lenders are usually low-interest, especially for borrowers with good credit, but P2P loans may not be suitable for raising large sums of money in a short time and are not widely available in many countries. Tested and trusted P2P lending sites include Peerform, Payoff, and Upstart.
Family and Friends
A perk of borrowing money from family and friends is that such loans may not come with interest at all. Also known as “private party loans,” these loans may offer amounts that vary based on the lender’s financial capacity. To avoid a strain in your relationship with the lender, you should take amounts you are capable of repaying, and backed with appropriate legal procedure.
Yes, you read that right. You can take a loan from your finances and loan it to your business. To prevent blurring the line, you can draft a contract expressly declaring yourself as the lender, and with defined repayment schedules, as well as penalties for defaulting.
In lending, the importance of signed agreements cannot be overemphasized. No matter your relationship with the lender, an agreement sets the necessary boundaries in place for a mutually beneficial transaction.