What Is Microlending?

Microlending Explained

Cheerful businesswoman meets with client
••• SDI Productions / Getty Images

Microlending involves granting small loans to people in need.

Learn how it works, how much you can borrow, and how to get started with microlending.

What Is Microlending?

Microlending is the process of granting "micro" or small loans known as microloans to those with financial need. These loans are generally used by entrepreneurs with a business idea or those who need extra cash to expand their business.

How Microlending Works

Loans to people with little income and less-than-decent credit are hard to come by usually come with exorbitant interest rates. As a result, the loan balance keeps increasing, and borrowers have an increasingly difficult time paying off their loans. Luckily for these borrowers, microlending has emerged as a socially conscious way to provide funds to individuals in need with affordable rates and terms to help them repay them.

Microlending started in 1976 with one man, Muhammad Yunus, who founded the Grameen Bank in order to make a small loan to a group of Bangladeshi women who used the funds to make and sell baskets and then repaid the money. Since then, microlending has spread to several countries. It has revolutionized aid efforts in developing countries and, with extremely high repayment rates (often reported at over 95%), it has helped dispel negative myths about economic sensibility in poor communities.

Microloans are similar in purpose to small business loans. But what makes microlending unique are the goals behind it, the players involved, and the sizes of loans.

Traditional lenders focus on earning a profit by charging interest and fees. Microlenders have more of an interest in development. Some certainly want to earn a profit, but the main goal is to help small entrepreneurs who would otherwise be unable to borrow launch or expand businesses, thereby reducing poverty in impoverished areas.

A modern microlending arrangement involves a microlending website (usually a nonprofit organization), investors, a microlender that lends to borrowers in a particular location (a financial institution such as a small nonprofit or large commercial bank), and a borrower in need:

  1. Investors browse the microlending website for one or more people or ideas in which they may want to invest.
  2. Investors can lend as little as $25 through a bank account, a credit card, or a payment platform like PayPal.
  3. The microlending website collects the funds and funnels them to the borrower through a microlender accessible from the borrower's country.
  4. The borrower pays back the microloan over time, plus interest. However, some organizations offer non-interest microloans.

As opposed to traditional lenders that simply hand out the money and let borrowers fend for themselves, microlending organizations might also provide coaching and training to teach these entrepreneurs how to run a successful business. These tools help businesses build a firm financial footing, which in turn helps ensure that the borrower will make enough profit to pay back their loan.

How Much Can I Borrow With Microlending?

Microloans, true to their name, are sometimes as small as $25, though they can go as high as $1,000. In many parts of the world, $25 goes far in the local currency, allowing an entrepreneurial person to buy a decent supply of inventory. Combined with some hard work, that $25 can be all it takes to produce a product and turn a profit.

The term "micro" is relative, however. Here in the U.S., the Small Business Administration (SBA) considers anything under $50,000 a microloan. That said, their average microloan runs about $13,000.

Most traditional lenders have no interest in microloan customers because it costs them too much to evaluate the creditworthiness of borrowers and underwrite small business loans. Those overhead costs eat into their opportunity for profit, as do the relatively low-interest rates of microloans.

Do I Need to Use Microlending?

People who obtain microloans are not typically wealthy business owners, but rather borrowers around the world who want to run or grow their own businesses, have relatively low incomes (at or below the poverty level) or insufficient or poor credit, therefore cannot qualify for an affordable loan from a traditional lender. Of course, those factors don't affect the quality of their ideas or their ability to run a successful business. That's why microlending is so important to these borrowers.

Microlending continues to grow overseas in developing nations, where markets are less formal and it's more difficult to access banking services, especially for those who aren't wealthy. Individuals in these areas stand to gain the most from microlending as the cost of living is considerably lower than in the U.S., and small-dollar loans can go a long way.

How to Get Started With Microlending

You can engage in microlending either as a borrower or a lender. The approach you'll need to take to do so will vary in each case.

How to Borrow Through Microlending

If you're looking to borrow a small amount of money, shop among various microlenders and traditional lenders to see where you can get the best deal.

The SBA provides a list of local microlending organizations by state, which is a great place to start if you're located in the U.S. But you can also check with online lenders and peer-to-peer lenders such as SoLoFunds.com, Prosper.com, or LendingClub.com.

It's also worth checking with your local bank or credit union. Even if you don't think you'll be eligible for a loan from one of these organizations, it's worth trying to find out for sure either way.

Once you know what your options are, compare all the terms (notably the loan amount, interest, repayment period, and any hidden fees), and choose a lender that best fits your needs and budget.

When you apply, which you can often do online, be prepared to provide personal or business financial documentation (pay stubs or cash-flow statements, for example), put up collateral if needed, and undergo a credit check.

How to Lend

If you're interested in lending money to entrepreneurs, whether it's a bakery down the street or a farmer on the other side of the world, you have plenty of opportunities. You can search for lenders in your area through the same SBA list that borrowers use.

An easy way to lend small amounts of money is with one of the first websites to popularize microlending, Kiva.org. Kiva offers a more hands-off investing approach, so if you want to be more involved in the business, you might consider another option. In addition, individual lenders don't make money off interest payments through Kiva.

You could lose money if borrowers can't repay their loans.

Is Microlending Worth It?

Borrowing money in the form of a microloan is a great way to get a small infusion of cash as a low-income or low-credit individual, especially in an impoverished area of the world where a small-dollar loan can stretch further. But microloans may be insufficient for those with greater capital needs or who live in areas with a high cost of living.

Similarly, lenders who simply want to turn a profit might be disappointed by microlending. For most microlenders, the primary motivator is the opportunity to help people who want to work hard but need access to affordable business capital. Like any kind of loan, unfortunate circumstances do happen, and you could end up losing money if borrowers can't repay their loans. However, the high rates of repayment on microloans help reduce the chances of that happening.

  • Microlending involves granting small loans of $25 to $1,000 to people in need, usually for the purpose of starting or growing a business.
  • It often involves investors funneling money to borrowers through a microlender via a microlending website.
  • People with low income and poor credit are the ideal borrowers, particularly those in countries with a low cost of living that allows the money to stretch further.
  • Borrowers can get funds through microlenders or traditional lenders but must be prepared to submit the necessary documentation and get a credit check.
  • Microlending is a good choice for a borrower who doesn't need much money, but lenders must accept the risk that they could lose their capital.