Web Reviews

Microlending Opens Doors for Investors and Borrowers Alike

Indianapolis, IN - June 6, 2011

“The primary goal of microlending is to empower people to create something that provides for self-employment and, eventually, wealth accumulation to lift them from poverty to self-sustainment.”

– Jim Cota

As the credit market tightened in recent years, an interesting trend has emerged to serve lending needs for businesses and consumers here and abroad. It‘s called microlending and, in some ways, it‘s changing the way people think about lending and borrowing.

Mircolending began as a way for people to offer very small loans to those in poverty and were designed to spur idea generation and entrepreneurship at the local level. The primary goal of these loans is to empower people to create something that provides for self-employment and, eventually, wealth accumulation to lift them from poverty to self-sustainment. While examples of the concept of microlending have been around for centuries, most people attribute the birth of modern microfinance to a bank in Bangladesh in the late 1970's.

With the emergence of the Internet, many of these organizations went online. Probably the best known is Kiva. Founded in 2005, Kiva‘s mission is to alleviate poverty through microlending. They “envision a world where all people hold the power to create opportunity for themselves and others.” So far, there are almost 600,000 people making more than $200 million available for loans through Kiva. Kiva boasts a repayment rate of 98.75% on their loans, which is better than many banks. It‘s a very active environment… this week alone more than $1.6 million has been loaned to 4,000 entrepreneurs. At an average value of $400, it doesn‘t seem like much to most of us. But for people living in poverty, it can literally be a lifesaver.

Recently, however, the concept has undergone a bit of a transformation. While many of the original microlenders were non-profit organizations like Kiva, it‘s increasingly becoming a for-profit enterprise, especially as the loans have moved from poverty-stricken locales into the western world. The result has been both good and bad, as you can imagine. But if done correctly, under the right kinds of oversight, they can provide a way out for people who need help and an interesting investment opportunity for people looking to get a better return on their money than is currently available in savings accounts, CDs, or money markets. One of the changes that has made this possible is the introduction of group lending.

Group lending is exactly what you might expect. Let‘s say your brother needed to borrow $1,000. Instead of you loaning him the money directly, you got nine of your friends to each put in $100. That $900, with your $100, gives him the amount he needs. But the risk of him defaulting is spread over the entire group, which, knowing your brother, makes it more palatable for everyone. Then, with each payment he makes (including interest), all ten of you receive a small payment. Over time, the entire loan is paid off, all ten lenders make a little money to offset their risk, and your brother has a clean slate.

Now there are several organizations online that allow you to do the same thing, for people who aren‘t related, with people you don‘t even know. In this world, each borrower submits their credit history along with their loan needs, the organization vets the information for accuracy and then operates as a middle man to disperse payments all around. As an individual investor, you can put in as much or as little as you like, and you can determine how much of your money goes to whom, allowing you further leverage to mitigate your risk. Two of the more popular options are Prosper and Lending Club.

Each offer basically the same services, so I‘ll let you take a look decide which you prefer. Prosper is offering a higher rate of return, but also a higher interest rate for borrowers. In each case, you can decide who to lend to and you‘ll see detailed information about who is borrowing, what the money will go toward, and what the payment options are. You can decide, for example, that you‘ll happily loan money to people to pay off another higher interest debt but you won‘t make the loan to help them buy that motorcycle they‘ve been eyeing. It‘s entirely up to you. The nice thing about both options is that you put your money into an account that you control, you decide how much (and to whom) to lend, and the organization takes care of the rest and takes a small fee. Right now, Prosper is offering an actual rate of return above 10%. Keep in mind that I‘m not a financial planner, so talk with a professional you trust before you invest in either of these organizations. I can tell you that Kiva has the highest possible rating with Charity Navigator and both Lending Club and Prosper have a B+ rating with the Better Business Bureau.

While microlending is interesting option for both borrower and lender, even Kiva will tell you that it‘s not a silver bullet, but one strategy among many to battle the huge problem of poverty. But there is ample evidence that it can help. For more information on the impact of microlending on poverty, see Freedom from Hunger.