Micro-Loans Small Loans, Big Impact

by Nancy Osborne, COO of ERATE

While we continue the debate on what led to the collapse of the sub-prime market, there is good news circulating in the financial world and it's what is commonly referred to as micro-loans. If ever there was a feel good story in the loan universe, this is it. Micro-loans are part of a wonderful and exciting new category of banking called micro-credit. The economist from Bangladesh who pioneered this type of financing, Muhammad Yunus, deservingly won the Nobel Peace Prize for his efforts. These loans are made available to some of the most impoverished nations and people as sadly there are over a billion people in the world who survive off less than $1 a day. Micro-credit has been implemented in over 40 countries world-wide and is even available in the United States within the inner cities of urban areas. Micro-loans are far easier to obtain than traditional bank loans and are granted in average loan amounts ranging from $200 (within third world countries) to $13,000 (within more developed countries). The loans are used for small self-employment endeavors which generate income for the recipients to help sustain their families as well as moving them towards the path of financial self reliance. These loans have proven to be amazingly beneficial in fighting the war on poverty and they happen to have default rates which are less than half that of the sub-prime loans made by U.S. lenders.

Micro-credit lenders obtain their capital from both individual and institutional investors. In 2003, it is estimated that over 60 micro-credit lenders extended credit in an amount exceeding three billion, this is double the rate of micro-lending just three years earlier. You may be familiar with the concept of compound interest and the way these loans work you could think of them as compound lending. As one loan (plus interest) is repaid these funds are then lent out again to others and in essence recycled as the benefits resulting from them grow exponentially. Repayment of the loans is driven by social pressure, it is a system that encourages social responsibility and has a repayment rate exceeding 98%. Loan recipients can only apply for future loans once the others within their particular pool of micro-loan borrowers have repaid their outstanding debts. Micro-credit programs are a powerful tool in fighting poverty as it is the very poor themselves who are motivated to improve their circumstances through their own efforts and with this type of lending an investment is made in their future and they are given the power and control to change their own lives rather than simply given a hand out. It is women who also play a significant role in the system of micro-credit as women are generally considered good credit risks in that they choose to invest any funds received to benefit their families. Because women are often responsible for the raising and upbringing of the world's children, by helping women the lives of children are simultaneously improved as well.

The most successful micro-credit programs re-fund new loans with repaid interest on existing loans and are most beneficial when marketing and technical assistance are also provided to the loan recipients. Business planning and training may also be required of a potential loan candidate before an application is approved. The maximum term for a micro-loan is normally about six years with each micro-lender developing their own credit and lending guidelines. The loans are typically made to start-up type businesses and may require some kind of collateral or the personal guarantee of the loan recipient. Interest rates charged on these loans are high and could be as much as 20% on an annual basis, however the cost of underwriting and administering such small loans is very high, and with the currencies within a loan recipient's country normally somewhat weak, a higher rate is charged to insure there is sufficient funds to convert back to an investor's dollars and euros. The interest that each borrower pays on their loan is used to finance the cost of lending to another deserving recipient. Because these loans are powerful life changers that enable those living in poverty to help themselves, they deserve our collective international applause and support as well as substantially more than the paltry 2% of the world's development budget estimated at $60 billion. For more information on micro-loans and how you can get involved go to: www.kiva.org

  Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.

"I am addicted to Bloomberg TV" says Nancy.