In this modern world of finance, one of the most commonly used applications is microlending. It is also known as microcredit or microloan. These small loans an issued by individuals and not any bank or any credit union. Apart from a single individual, these loans can also be aggregated across a large number of individuals. All they contribute a part of the total amount.
Money Lending Industry
The peer-to-peer money lending industry has revolutionised the economy as well as the way people do business today. The financial sector also plays a significant role and has made a few impressive advancements that leverage P2P applications.
- Microloans are mostly common in Third World countries because traditional financing is not readily available.
- These loans are typically given to people to start small businesses.
- The lenders charge interest on the money loaned, and the money is to repay before the maturity of it.
- The credit of such borrowers is typically quite a low, and the risk of default is quite high.
Microloans today command the market interest rates, and this makes it much more promising and enticing for the investors.
The Risk And Reward
The microlending model has some risks as well as some reward. The rise of microlending concept facilitated by the development and use of the internet that has enabled worldwide interconnectivity. It has helped people to put their savings to the best method by lending it to people who need the money and earn interest on the money loaned.
The process is simple where the lenders and borrowers find each other online to interact and transact.
The credit rating of the borrowers calculated by using different data such as:
- The borrower owns a home
- The credit
- The background
- Repayment history in case the borrower took a microloan in the past.
The type attribute of the microloans is that the borrower has to pay a bit more than the traditional credit even if the credit score is excellent. That means the lenders typically earn a far better return on their money lent out than they would have through traditional savings or from any other type of investment.
Attributes Of Microloans
The microloans have its specific characteristics and features that make its quite different from traditional borrowings that you may get from a bank, a credit union or from any other alternative or online money lending sources such as Liberty Lending.
- These loans usually are not backed by any collateral and therefore, the lenders are at risk of losing the money in case a borrower defaults.
- Typically, the best-rated borrower will have to pay a minimum rate of interest of 6% annually on loan.
- On the other hand, the high-risk borrower may have to pay a rate of interest as high as 32% or even more if the risk is very high.
Ideally, any investor may gain outsized returns on such investments as compared to other forms of lending even if the money loaned at 6% annual interest, provided the amount of risk is comparatively low.
The Risk Factors
There is a fair amount of risk in such form of money lending and that there is no collateral to recover the money in case a borrower defaults, the lenders mostly invest only a small amount of money on each loan. However, they may fund a large number of portfolios consisting of several dozens of microloans. That means any single borrower may have their investment supported by a large number of lenders wherein each contributes only a small percentage of the total amount loaned.
- This spreads the risk across an extensive array of loans that have different credit qualities and other attributes.
- This also means that the lenders ensure that their entire portfolio not wiped out even if one or a couple of borrowers fail to pay the money back.
All lenders of microloans are individuals actually because the financial institutions, banks and professional investors find that the risks are far too substantial than the rewards they would receive from such form of money lending. This means that most of the microloans that you may get are peer to peer form of money lending in the purest sense.
About The Microlending Users
Microloans are mostly used by the users who find one of these two primary purposes served. These are:
- First, it is used to help the poor people in the Third World countries in starting a small business. Ideally, these lenders are individuals, maybe from the state, who pledge a specific amount of money to give as a loan to a worthy entrepreneur who may be residing in another country. Several companies administer the microlending process and purposes on the humanitarian ground. To avail such loans, the borrowers usually have to describe the type of business they want to do, the ordering process and principles and create and present a proper business plan that outlines the day-to-day operations. More often than not, the borrowers may also have to submit a short personal story or biography along with the necessary documents.
- Secondly, it also lent to individuals staying in a developed country who may have a low credit score or ad credit being unable to obtain loan from traditional sources like banks. It also lent to the people who seek to borrow small amounts of money that fall far below the values required by any conventional bank. Once again, some companies administer peer-to-peer microlending for such specific purposes.
To sum up, microlending has enabled people to borrow a small amount of money much more quickly. It can acquire any number and kinds of reasons, but that should be made explicit to the potential lenders. If the lender does not trust the borrower, they will abstain from lending the money.
In some cases, the lender may not fund the borrower fully if the project cannot attract enough lenders to contribute.