What Is Alternative Lending?
Alternative lending refers to a broad range of lending solutions for consumers and business owners that do not involve traditional banking institutions. These options tend to provide flexible repayment schedules and are generally more lenient when it comes to approval.
Because small and medium-sized businesses can have trouble obtaining financing from a traditional bank, alternative lending has quickly grown into a necessity for many business owners.
After the financial crash of 2008, with banks tightening loan requirements, non-traditional lenders flourished. While banks were reluctant to lend to smaller businesses – which they saw as a high-risk investment - alternative lenders offered not only financing, but speedy payouts, easy approval processes, and much less paperwork.
Additionally, because they were not as regulated as banks, alternative lenders could offer both traditional and non-traditional options, including term loans, lines of credit, invoice financing, and short-term loans, among others. While some alternative lenders operate just like traditional banks, many have pioneered different forms of lending, such as peer-to-peer (P2P) lending.
Also called marketplace lending, P2P uses an online platform to match borrowers with suitable lenders. The ease of application, quick results, and generally low interest rates have led to huge success in the marketplace and opened the way for many others forms of lending.
How Alternative Lending Works
Broadly speaking, alternative lenders will grant loans or lines of credit based on the borrower’s information. As opposed to traditional lenders, they can be less strict in their acceptance criteria.
If accepted, the offered loan amount and interest rate will be based on the applicant’s needs, credit score, and past revenue.
After the loan has been granted, the borrower will have to repay the amount, with interest, across regular and predictable intervals.
When Using an Online Lender Makes Sense
Using an online lender makes the most sense when a borrower is unable or unwilling to take out a loan from a standard bank.
In the case of small business loans, beyond the usual services, online lenders are able to offer financial products that traditional lenders typically do not, including merchant cash advances and invoice financing.
Alternative Lenders vs. Traditional Banks: What's the Difference?
There are big differences between alternative lenders and traditional banks and, of course, there are pros and cons to both. While alternative lenders can offer looser terms in regards to approval, repayment schedule, and lending speed, traditional banks operate differently.
Strict approval criteria, diligent repayment policies, and deliberative processing times make banks less attractive for those who are on an urgent timeline.
Conversely, with greater flexibility comes greater risk to the lender. As such, alternative lenders usually charge greater interest rates than their traditional counterparts.
All in all, however, alternative lenders offer significant benefits:
Fast turnaround: Because alternative lenders do not have many of the regulations and underwriting standards that banks do, they are often able to offer loans within a very short time. Their quick turnaround is also due to the ease of their application process. Many of these lenders require little in the way of paperwork as their underwriting process is highly automated, with some developing algorithms that could predict defaults in a way that traditional underwriting couldn’t. They can also use data mined from social media and internet usage to customize borrowing terms.
Flexible terms: While banks are limited to certain types and amounts of loans, alternative lenders have a lot more room for innovation. Some companies will consider a wide variety of items as collateral, from equipment to outstanding invoices.
Additionally, because of their lack of overhead and their streamlined processes, they can afford to make smaller commercial loans than a traditional bank, sometimes as low as $5,000.
Easy applications: Most alternative lenders are online institutions and, as such, offer a smooth online experience. Many lenders’ applications can be filled out on a desktop or mobile device and could take as little as half an hour to complete. Additionally, as stated above, their use of algorithms and data in their underwriting means that there is much less paperwork for borrowers to submit.
Alternative Loan Options
Term Loans
Term loans are variable interest rate loans with pre-arranged repayment periods, which, in the case of small businesses, usually range between 10 or 20 years.
Unsecured Business Loans
The unsecured business loan does not depend on credit scores, but on sales performance. The lender will consider the business’ financial performance to decide whether they are eligible. This type of loan is known for a fast payout, sometimes in as little as 48 hours.
Lines of Credit
For small businesses, lines of credit offer a greater degree of flexibility than a standard loan. With lines of credit, the business is allowed to borrow up to a certain limit, just as individuals would do with a credit card. And, just like a credit card, repayment and interests are only owed on the amount withdrawn, rather than the granted total.
Invoice Financing
Invoice factoring, or invoice financing, is a process by which outstanding accounts receivable, or invoices, are bought by financial third parties, or factor companies, in exchange for cash advances. This makes it a good option for businesses with a large percentage of their income tied up in unpaid invoices.
Merchant Cash Advances
A merchant cash advance, or credit card receivable funding, is a process used to fund small businesses where a business owner can receive a cash advance based on the speculated amount of future credit card sales.
At the conclusion of each business day, a pre-determined percentage of the daily transaction amount is transferred to the lender, until such time as the advance is fully paid off.
Equipment Loans
Equipment loans, specifically for small businesses, are loans meant to assist in the purchase of business-dependent equipment.
As opposed to other loan types, which require outside collateral, equipment loans’ resultant equipment acts as its own collateral.
Microloans
Many non-traditional lenders offer the option of a microloan to help a business finance necessary inventory, equipment, or another operational aspect. These loans could be as small as $500, but usually require that a business provide collateral in order to qualify.
Pros/Cons of Alternative Lending
Pros:
- Easy application process with little paperwork
- Quick underwriting process
- Fast payouts
- Easier qualification
- Smaller amount loans available
- Flexible repayment schedules
Cons:
- Higher interest rates and APR
- Possible penalties for prepayment
- Less equity available for other initiatives
- Repayment schedules could be very frequent, sometimes requiring daily or weekly payments.
How to Find the Best Alternative Lender for You
In order to find the best alternative lender for your business' needs, carefully examine a lender's offer. In addition to the maximum loan amount, loan term, and lending speed, the penalty fees and interest rates are critical.
All told, excessive costs and fees can make the difference between a boom and a bust for the business in question.
The best alternative lender, the possibility for predatory fees aside, will customize its offer based on the specific business information.
Credit scores, average revenues, length of time in operation -- these factors will ensure that an alternative lender not only provides favorable terms but also predictability.
Since a small business loan limits the amount of available equity, predictability is essential to proper long-term planning.
In the event that a potential borrower wishes to compare options and terms, our top ten lenders of small business loans is a good place to get started.