Microlending Definition and Examples

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If you've seen or heard ads about how to get quick, easy loans, you might think companies hand out small business loans and personal loans left and right. Banks constantly advertise that you can borrow cash to use for anything you want. But people with little credit or poor credit know that isn't the case. Those funds are mostly only available to you if you live in the United States and have decent-to-good credit.

Here in the U.S. and around the world, loans to people with less-than-decent credit usually come with exorbitant interest rates. As a result, the loan balance keeps increasing and borrowers have an increasingly difficult time paying off their loan. Luckily for these borrowers, microlending has developed as a socially conscious way to provide needed funds at more affordable interest rates.

What Is Microlending?

Microlending involves granting small loans to people in need. These loans are generally used by entrepreneurs with a business idea or those who need extra cash to expand. In that sense, they aren't much different from small business loans. However, microlending is actually much different. What makes these loans unique are the motivations behind it, the sizes of loans, and the people involved.

Motivation

Traditional lenders solely focus on earning a profit by charging interest and fees. Microlenders have more of an interest in development. Some of them certainly want to earn a profit, but the main goal is to help develop businesses for small entrepreneurs who would otherwise not be able to borrow.

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.

Microlending started in 1974 with one man, Muhammed Yunus, who made a small loan to a Bangladeshi woman. That woman was living in poverty, but she used the loan to make and sell bamboo stools to feed her family. Since then, microlending has spread to several countries. Many banks and non-bank entities now offer microlending services. It has revolutionized aid efforts in third-world countries and, with extremely high repayment rates, it has helped dispel negative myths about economic sensibility in poor communities.

Loan Size

Microloans, true to their name, are sometimes as small as $25, although they can be much larger. In many parts of the world, $25 or $50 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 in some cases. Here in the United States, the Small Business Administration (SBA) considers anything under $50,000 a microloan. That said, the SBA reports that 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.

Borrowers

People using microloans are not typically wealthy U.S. business owners. These borrowers often run their own businesses, have relatively low incomes (at or below the poverty level), and cannot qualify for a loan from a traditional lender. However, 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.

How to Borrow

If you're looking to borrow a small amount of money, shop among 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. It's also worth checking with your local bank or credit uniononline lenders, and peer-to-peer lenders such as Prosper.com or LendingClub.com. Even if you don't think you'll be eligible for a loan from these organizations, it's worth trying to find out for sure either way. Once you know what your options are, you can compare all of the terms and choose a lender that best fits your needs.

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. Keep in mind that individual lenders don't make money off interest payments through Kiva. Kiva also offers a more hands-off investing approach, so if you want to be more involved in the business, you might consider another option.

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, it's worth noting that microloans have extremely high rates of repayment.