What Is Microlending?

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DEFINITION

Microlending involves granting small loans to people in need.

Definition and Examples of Microlending

Microlending is the process of granting small loans known as "microloans" to small business owners that do not have access to financial products.

  • Alternate name: Peer-to-peer lending
  • Acronym: P2P lending

For example, if a small business owner in El Salvador needed $1,500 for repairs on equipment necessary to run their business, that owner could sign up with a local organization contracted by a P2P loan service platform to look for a lender. The platform matches up an investor or lender with the business owner. Both parties agree to the terms of the microloan, and the funds are transferred to the local organization, and then to the business owner.

The owner uses the funds in the agreed-upon manner and repays the loan according to the terms of the agreement.

Small loans are available from many financial institutions, but microlending in its popular form is between individuals using peer-to-peer lending platforms.

How Does Microlending Work?

Online peer-to-peer lending platforms have emerged as the easiest way for borrowers to locate lenders. Microlending started in 1976 with Muhammad Yunus, who founded the Grameen Bank 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 globally, revolutionizing aid efforts in developing countries.

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. You can find microloans on peer-to-peer lending websites like Kiva, which allows people worldwide to lend to, and borrow from, each other.

Goals of Microlending

Many microlenders have more of an interest in development. Investors are looking at it as an investment with the possibility of returns, but the main goal behind microlending is to help small entrepreneurs who otherwise would be unable to borrow for, launch, or expand their business.

Microlending has also grown into a social movement to help reduce poverty in areas where people do not have access to loans.

Microlending Process

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:

  • Investors browse the microlending website for one or more people or ideas in which they may want to invest.
  • Investors can lend as little as $25 through a bank account, a credit card, or a payment platform like PayPal.
  • The microlending website collects the funds and funnels them to the borrower through a microlender accessible from the borrower's country.

The borrower pays back the microloan over time, plus interest. However, some organizations offer non-interest microloans.

How Much Can I Borrow Using Microlending?

True to their name, microloans are sometimes as small as $25, although they can be much higher. In many parts of the world, $25 goes far in the local currency, allowing an entrepreneur to fund much of what they need. Combined with some hard work, $25 could be all it takes to produce a product and turn a profit.

The term "micro" is relative, however. The U.S. Small Business Administration (SBA) considers anything under $50,000 a microloan. The SBA states that the average microloan runs around $13,000.

How to Get Started With Microlending

You can begin as a borrower or a lender. The approach you'll need to take will vary in each case.

How to Borrow Through Microlending

If you're looking to borrow a small amount of money, shop among various micro 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. You can also check with online lenders and peer-to-peer lenders such as Kiva, SoLoFunds.com, Prosper.com, or LendingClub.com.

There are several web-based platforms available. You should do your research on any that you might want to use, to make sure they are legitimate.

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, or find a platform online.

One 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. Individual lenders don't make money off interest payments through Kiva.

The risk of lending to borrowers in other countries or through online platforms is that you could lose money if the borrowers can't repay their loans. You don't have any legal protections or recourse if this happens.

Is Microlending Worth It?

Borrowing money in the form of a microloan is a great way to get a small infusion of cash if you are cannot get or afford a traditional loan. However, microloans may be insufficient if you have a larger financial need or live in an area where the goods or services you need are more expensive than a microloan can cover.

If you're looking to become a lender, you might be disappointed by the returns microlending offers. For most microlenders, the primary motivator is the opportunity to help people who want to work hard but need access to affordable business capital. However, if you enjoy investing for the benefit of others, microlending can be a satisfying endeavor.

  • Microlending involves granting small loans starting at about $25 to people in need, usually to start or grow 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 and might not see much of a return.

Article Sources

  1. Stanford University News. "Nobel Winner Pushes for Banking With a Conscience."

  2. Kiva. "Make a Loan, Change a Life."

  3. U.S. Small Business Administration. "Microloans."

  4. U.S. Small Business Administration. "List of Lenders."

  5. Kiva. "Kiva Terms of Use Agreement."