Author: Thomas F. Pfeifle
What are Loans?
A loan is the lending of money to another third party, a borrower, who incurs a debt and is liable to pay interest till the principal sum is repaid. Usually loans are given with a fixed period, a fixed or variable interest rate and predefined repayment schedules. If the debtor is not able to repay the debt and the interest, the lender has claims on his or her property equaling the sum borrowed plus interest. The lender gives the borrower his equity as investment to receive interest.
In most cases a loan is lent in form of money but can be equally tangible and property. In most cases people act as borrowers for money, when they take a loan from a bank, to finance a house or something else. But in this article, we focus on the lender’s perspective, because there are also multiple possibilities for you as an individual to lend money to others as an investment.
How to earn money through giving loans
There are various ways of lending money to others. In this case we only deal with the ones which are executed by certain institutions and organizations and do not include informal private lending, meaning we do not explain how you can directly lend money to your neighbor.
The first and traditional option,is to give your money to the bank, which lends the money to others, and you receive annual interest on the money you gave the bank. In the past this was a very common and feasible method of growing your wealth, as banks offered interest rates above 5% and higher. Since the ECB (European Central Bank) has lowered the interest rate to almost 0%, you will probably only receive 0,001% interest on your money, which is literally nothing and is not a profitable investment anymore
Nowadays banks even have fees above the interest rates and in addition comes the inflation rate, which causes your money to slowly shrink year by year.
Another and very modern way to lend money as an investment is via Crowdfunding, which is offered widely by various platforms online. The goal of crowdfunding is to raise money for projects and people by collecting small amounts of money from a high number of different investors. The investors are most commonly individual persons and small businesses who use this to let their money work for them. In most cases of crowdfunding the funded sum is requested by small businesses and start-ups who need money to start their business.
On the different crowdfunding websites, you can choose between various projects to invest in. Beneficial about these are the high interest rate which usually lies above 5%, the possibility to define the purpose for which the money should be used and additionally the person or organization which should receive the money. The different projects, one can invest in are classified in different risk categories, where you can choose from. Choosing a low risk project, has a high certainty that you are getting your money back, but also low profit potential whereas high risk projects have lower certainty about the repayment, but also higher potential for high profits.
However, investing in crowdfunding also has some disadvantages. One of the biggest is that there is no promise, that if the project, for instance a start-up, fails that you do not get your money back. With failure of the project, your money is lost. Additionally, depending on the Crowdfunding platform, there are minimum investments. So, to speak, one must invest a minimum amount, like 5000 Euros, to be able to invest. People with smaller budgets are left behind.
Peer to Peer Lending
Peer to Peer lending enables individuals to directly lend money from one person to another.
One of the biggest advantages for lenders, are the high interest rates, which are multiple times higher than the interest rates of banks etc. A higher interest rate for the lender, also means high interest to pay for the borrower. So why do people do not use banks with low interest rates, to borrow money? The answer is very simply. Often the borrowers do have a bad loan ranking, which disables them from getting a loan from a bank or comparable financial institution. Moreover, many P2P loans are addressed to foreign borrowers in foreign countries, where the banks are unstable and not trustworthy, and the conditions are equally bad.
There is a wide range of providers like Mintos or Bondora, who offer good conditions, are easy to follow and guide you to through your first steps of investing. They usually do not require a minimum amount and one can even invest starting from 1 Euro. They also offer packages like auto investing, where you do not have to choose, as a computer does the work.