Lending is a major part of the financial services industry. Lending is the process by which money is borrowed and then repaid with interest. The two main types of lending are formal lending and informal lending.
The main difference between formal lenders and informal lenders is that formal lenders are legal entities while informal lenders are not.
Before we move to the differences, let’s understand what are Formal Lenders and Informal Lenders:
- Formal Lenders: Formal lenders are financial institutions that offer loans to individuals or businesses. These lenders are regulated by federal, state and local laws, and they must follow strict guidelines when making loans.
- Informal Lenders: Informal lenders are individuals who lend money to other individuals or businesses. They are not typically regulated by the government, and they do not have to follow the same guidelines that a traditional bank would.
Now, let’s move to Formal Lenders vs Informal Lenders:
Major differences between Formal Lenders and Informal Lenders
|Formal Lenders||Informal Lenders|
|Formal lenders are banks, credit unions, microfinance institutions, and other institutions.||Informal lenders include friends or family members.|
|Formal lenders are businesses that lend money and have a standard set of rules and regulations for their customers.||Informal lenders, on the other hand, may not be professional in their approach to lending, which can make them more risky for borrowers.|
|The formal lender is more likely to give you a better deal than an informal lender—but they also charge higher interest rates.||Informal lenders are more flexible with their requirements and offer lower interest rates, but they aren’t as safe as formal lenders.|
|Formal lenders use credit scores and other financial information as part of their decision-making process when deciding whether or not to extend a loan. This means that your credit score is likely to play a role in whether or not you’re approved for financing from one of these types of lenders.||Informal lenders usually focus more on your ability to repay the loan than on whether or not you can afford it based on your income and assets.|
|The loans tend to be larger than those offered by informal lenders, and they can last for years instead of just months.||The loans are usually small and short-term, say for one month or less.|
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Note that sometimes, the question might also be asked as “distinguish between Formal Lenders and Informal Lenders”.
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In conclusion, the difference between formal lenders and informal lenders is that the former is an institution that provides loans to people, companies, and other entities, while the latter is a person who lends money.
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