What Are the Risks and Rewards of Microlending?

The term microlending, which is not a new concept, has created a lot of buzz over the last decade. If you are an investor or a borrower, you may have come across this label, which comes with its risks and rewards. If microlending is something you want to explore in the future, keep reading to find out more details about it.

The origin.

The modern concept of microlending or microfinancing originated in 1983 with the Grameen Bank in Bangladesh, founded by Muhammad Yunus, a Nobel Peace Prize awardee. He used his own money to offer small loans at low-interest rates to those struggling in a small town called Jobra. 

Yunus’s concept spread across the world quickly, and various financial institutions began offering microloans to many third-world countries. 

Today, microlending has turned into a big business for various profit and non-profit organizations that lend money to small business owners, students, women, veterans, and individuals from minority groups.

How does online microlending work?

Investors looking to loan and borrowers looking to borrow choose a trusted online microlending platform. 

Each potential borrower receives a rating, which is calculated by the platform using the user’s credit history, assets owned, and their commitment to repay microloans borrowed previously on the same platform. 

The AI-powered platforms determine whether a borrower is a high-risk or a low-risk applicant.

Since there’s less security in this kind of investment, the interest rates for borrowers are usually high.

For instance, the interest rate for the cheapest microfinance loans is 6%, which increases more than 30% for borrowers with the worst credit score.

Difference between microlending and peer-to-peer lending.

Peer-to-peer lending is an extension of microlending, which involves lending money to unknown individuals without involving any financial intermediaries. P2P lending takes place through online platforms like Lendee.

Unlike microloans, P2P lending programs are meant for profit-making. The interest rates are usually competitive in peer-to-peer lending, which works in favor of most borrowers, and even lenders get good return rates.

Rewards and risks of microlending for borrowers.

Rewards

• Microlenders are interested in your ideas and passion. With a well-thought and exceptional business plan, you can secure a loan much faster from a microlender than a traditional bank.
• If you have a short credit history, it is unlikely for you to qualify for a bank loan and more likely for you to qualify for a microloan.
• If you want a business microloan for less than $50,000, it can be difficult to find a bank willing to help you. On the other hand, microlenders can be of assistance when you need less cash to support your success.

Risks

• A big drawback of borrowing money from a microlender is a potentially high-interest rate. For example, if your interest rate is 18%, it may not be a good idea to take a microloan if your business can’t cover both the principal amount and the interest.
• Another risk of borrowing a microloan is that it can be a time-consuming process. As other businesses apply for microloans, there can be a delay in getting a response for your application.

Rewards and risks of microlending for lenders.

Rewards

• Consider microlending as a form of philanthropy. Your small financial help can change someone’s life completely.
• You can diversify your investment portfolio, create more passive income opportunities, and get better return rates than traditional investments. 

Risks

• One of the biggest risks of microlending is losing money to rogue borrowers. Not all borrowers are honest. Some individuals don’t shy away from presenting fake stories to take advantage of microlenders.
• On some occasions, there can be uncertainty about incoming payments.

The bottom line.

Microlending is a product of financial innovation that supports the growth of the P2P economy.

Lenders looking to make additional and higher profits may help fund those borrowers that are not eligible to get help from the traditional sources.

Every individual should weigh the risks and rewards of borrowing and lending according to their current circumstances.

Whether you are new to microlending or an expert, you can explore Lendee.