Microlending Definition and Examples

Farming
••• Thomas Barwick/Stone/Getty Images

If you've seen tons of online ads about borrowing money or heard radio ads on how to get quick, easy loans, you might think companies hand out small business and personal loans left and right. Banks constantly advertise that you can borrow cash to use for anything you want. Those funds might be readily available to you if you live in the United States and have decent to good credit.

However, loans don't come so easily to people with poor credit. Here in the U.S. and in many other locations around the world, especially in third-world countries, borrowed funds usually come with exorbitant interest rates, which keep increasing the loan balance and preventing the borrowers from ever actually paying off their loan. For these people, microlending has been developed as a socially-conscious way to provide the funds these borrowers need at more affordable interest rates.

What Is Microlending?

Microlending involves granting very small loans to people in need. These loans are generally used by entrepreneurial people wanting to start a business, or those who need extra cash to expand. Microlending is unique because of the motivation behind it, the size of loans, and the people involved.

Motivation

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

Microlending organizations might also provide coaching and training, to teach these entrepreneurs how to run a successful business with enough profit to pay back their loan, as opposed to just lending money and letting borrowers fend for themselves.

Microlending started in 1974 with one man, Muhammed Yunus, making a very small loan to a Bangladeshi woman living in poverty so that she could make and sell bamboo stools to feed her family. It has since grown to operate through many different banks and non-bank entities, in several countries. It has revolutionized aid efforts in third-world countries and, with extremely high loan repayment rates, has shown that the poor want a hand up much more than a hand-out.

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 very far and can buy a decent supply of inventory for an enterprising person who can, with some hard work, 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, and there's little opportunity for them to earn a profit.

Borrowers

People using microloans are not typically U.S. business owners with plenty of resources. These borrowers often run their own businesses, have relatively low incomes, live at or below the poverty level, and cannot qualify for a loan from a traditional lender. However, they still have good ideas and the ability to run a successful business, and microlending serves an important need for them. Microlending continues to grow overseas for borrowers in developing nations, where the poor have no access to banking and markets are less formal than in the United States.

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  by state, which is a great place to start. 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 about your eligibility to borrow as well. Compare all of the terms before you choose a lender.

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. An easy way to lend small amounts of money, although you won't earn any interest, is with one of the first websites to popularize microlending, . Kiva.org offers a more hands-off investing approach, but if you'd like to get more involved, search out lenders in your area, starting with the SBA list linked to above.

Microlending isn't just about making money; it's about helping out people who want to work hard and need access to affordable business capital. Unfortunate circumstances happen, though, and you could actually lose money if borrowers can't repay their loans, so only lend money that you can really do without.