What is Micro-Lending?
Micro-lending is a peer-to-peer lending system that links accredited investors with individuals or businesses that need capital. The individual investors who provide capital for loans function much like how a regular bank would for investors who would otherwise not have access to funds. Someone who needs capital to expand their business, buy a wedding ring, or even in some cases buy something as simple as seeds will post on a microlending platform and investors have the option to lend them money subject to the agreed upon interest rate and loan period. The micro-lending market is rapidly expanding and estimated to grow at a CAGR of 15.56% until 2020 by Research and Markets.
There are, however, some key differences between micro-lending and banks:
Banks can make much larger loans than your typical micro-lending platform is able to (hence micro), even with the pooling of investor funds (caps at about $500,000).
Microlending platforms will typically have a smaller time horizon (few months to 5 years) for repayment than banks.
While banks typically rely almost entirely on FICO scores, micro lending platforms are not afraid to experiment with various other non-financial metrics that will have an impact on repayment of the loan. For instance, Upstart relies on FICO scores in addition to what they call “signals of potential” to identify more candidates for loans who might not have enough of a credit or employment history for other institutions. Some of these variables are: degree attained, university attended, area of study, occupation, etc.
Micro-loans are sometimes mission based to help facilitate capital to specific groups or third world countries who don’t have access to adequate (if any) financial institutions. Those interested in ESG investments might also find some great opportunities in microlending to support small businesses and diversify their holdings. Kiva allows lenders to loan as little as $25 to help people around the globe gain access to opportunities they otherwise would not. 100% of your loan also goes to directly to borrowers, Kiva does not charge interest or fees to borrowers and is funded by individual donations and grants from supporters. Grameen America, with key backer Ray Dalio, Founder of Bridgewater Associates, invests exclusively in women entrepreneurs and to date has invested over $1 billion dollars in their businesses.
Wrapping it Up
Micro-lending fills a variety of voids that existed prior to their inception. They help jumpstart the economy by facilitating capital to entrepreneurs who would otherwise be unable to start businesses on their own. They allow another form of charitable giving in a smaller sense, and in some cases a small return on the loan. Micro-lending platforms are also willing to be considerably more innovative than the archaic large bank lending process that relied almost entirely on FICO scores to determine eligibility, opening more avenues for auspicious individuals and mature companies to gain funding.
All things considered, micro-lending is a great tool to diversify your investment holdings, support a cause or simply generate additional fixed income in retirement for qualified accredited investors.