How lending companies make profit

Apr 24th, 2020

Introduction

The art of lending or financing is a concept that has been around since the beginning of civilization itself. Thousands of years ago, farmers used their grains and seeds to borrow capital and also used livestock as a repayment option.

Ever since then, the lending system advanced to become the complex financial structures we know now.

What is Lending?

It merely means giving out money or property to another individual with the expectation that it will be repaid in the future. In a financial context, lending includes different kinds of commercial loans. 

Who are Lenders?

Lenders are financial organizations or institutions who are in the business of giving out loans. While individuals can also be called lenders, their motive for lending may differ from that of a financial institution who are in it to make a profit. Overall, they’re also called creditors.

When your family member lends you money, they may not be necessarily looking to make a gain for themselves; they probably want to bail you out of a financial situation. But that cannot be said of financial institutions such as banks and credit unions.

These loan companies in Nigeria expect not only to be reimbursed. They also expect to be paid with interest; which is the reason for this article.

Different Types of Lenders

Traditionally, lenders are often referred to as banks, cooperative societies, credit unions and any other form of financial institutions. In reality, lenders have expanded beyond the scope of banks and associations. 

They are referred to as less traditional sources of funds for personal or small business loans – and they include

  • Family and Friends – they are sources of funds that can bail you out of emergencies from someone you already know. This could be any member of your family or friends. However, no matter how close you are, draw up a loan agreement when taking the loan.
  • You can also borrow money from yourself. This is common to lending into your own business. All it takes is the required discipline to treat yourself as a separate entity from your business. This will encourage you to make your repayments when they fall due.
  • Peer to peer lenders – these are sources of finance you earn by association. Like club or association lenders. They are not established to grant members loan. However, they could lend a hand to a member in need.
  • Crowdfunding – it involves raising a small amount of cash from many people. The best thing about crowdfunding is it doesn’t require an interest payment 

How do lenders make money?

It’s straightforward. Mortgage brokers, banks and credit unions make their profit from the interest they charge on your loan offer. This is referred to as the cost of a loan. As lending money can be a risky business, these lenders charge an interest rate depending on the risk involved. The higher the risk of not paying, the higher their interest rates.

Think about it – While lenders may seem like bad guys, they are vital to the development of the economy. For example, When You go to request a bank to request a rent loan, the bank takes funds from their depositor (savings and money market accounts) and offers you the credit; at a higher rate 

The loan enables you to pay your rent. The landlord now has more money to pay his staff. The employees of the landlord now have money to circulate to businesses. Other businesses, in turn, grow the economy.

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