A microfinance loan is a loan extended by non-traditional lenders to people who are not served by traditional banks, such as lower-income borrowers, people without collateral, or people with lower credit scores. It does not necessarily refer to the loan amount, although most loans are small – from the $500 range to thousands.
Microfinance loans may also be called microcredit. The broad term microfinance implies other services such as specialized savings accounts, insurance or other financial services for the same underserved market.
- Who Uses Microfinance Loans? – Usually small business owners or entrepreneurs, or those wanting to become one. They cannot acquire bank financing because of the risks associated with their ventures, the smaller size of the loan required, their limited experience, or the variability of their income. Many are self-employed.
These people may also be unable to secure peer-to-peer loans because of a low credit rating (600 and below), or because investors do not think the return of their venture will be attractive enough to invest in.
Typical customers might be smaller retailers, artists, street vendors, food service truck operators, caterers, writers, part-time workers, and those operating businesses out of their home. By starting with relatively small loans, they can build creditworthiness and qualify for larger loans – eventually establishing a credit history suitable for traditional bank loans if needed.
Microfinance loans are targeted at those in the lower economic levels who see a financial opportunity and need a relatively small amount of funding to pursue it. Microcredit is not for those who are so deep in poverty that they cannot pay the loan back.
Microfinance loans have a surprisingly high rate of payback given the risks– over 90% by some estimates.
- Who Provides Microfinance Loans? – Many are offered by non-profit organizations. Accion is one of the largest and best-established non-profit microfinance groups, enjoying a worldwide presence. However, microfinance loans can be offered by for-profit entities, or microfinance branches of traditional banks.
- What are the Loan Terms? – Six-to-twelve-month terms are common, with terms up to five years. Loans can range anywhere from $500 to tens of thousands of dollars for those with established repayment records and solid business plans.
Interest rates are high but reasonable compared to the risk – 10-15% is not uncommon. As with any other loan, the interest rate will vary based on the amount of risk you represent, the amount of money you need, and the length of the loan term.
There may be other costs, such as application fees and closing costs. Check with the individual lender.
- How Do You Get a MicroFinance Loan? – You will need to fill out an application so the lender can assess your risk. Microfinance companies will often lend with lower credit scores (they can be in the 500's). The lender will look at your bill payment history, cash flow history and expected income, and your overall debt (personal and business).
You will also need to provide a business plan along with cash flow projections, and possibly a market study. Most microlenders will attempt to guide you to the correct resources if your application needs work, or you are unfamiliar enough with the basics of a business plan that your business is likely to fail.
In essence, microfinance fills the niche below what traditional banks would serve, overlapping a bit with P2P and crowdsourcing options. If you have an economic opportunity that you cannot finance through traditional banks or P2P lenders, and you have a solid business plan and reasonable means of payback, microfinance may be for you.
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