Microloans Part 1 – What Are Microloans and How Can I Invest in Them?

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Recently, I made my first ever microloan / microfinance investment, using a microfinance site called Microplace.
The loan, at the moutainous amount of $20, was to help finance entrepreneurs in Ecuador with their start-up businesses. These businesses include a diverse array of categories such as water-treatment processing, grocery stores, and clothing weaving.
Furthermore, I was recently reading through an article on Wealth Pilgrim about the subject of whether or not investments in “green” companies should be considered as part of your retirement money or as a donation.
As I was reading this, I began to also wonder how microloans should be treated. Therefore, I thought it would be a learning process for everyone (including me) to investigate some more about this subject.

I will address this subject in two parts.

What is a microloan?
To start off, we first need to know what exactly a microloan is.
A microloan is pretty easy to understand. It is a loan to poor individuals around the world (mostly in developing countries) to provide them funding for starting their own business.
What makes these loans different than normal loans is that they are typically in small amounts ($30-$200), have to be repaid in weekly installments (this discourages default), and typically have a short term of 3-6 months.
The individual borrowers are charged an interest rate on the loan amount until it is repaid. At the end of the loan term, the individual pays back the money to the lending institution.
Some excellent resources for additional reading material can be found at the links below from Microplace.com and Wikipedia.org.
Who offers microloans and how can I participate?

From a personal access point of view, a microloan works as follows:

  • 1) You, or another individual that has extra money that he or she wants to invest, goes to a microloan broker. This usually happens through their website. Several common brokers are listed below.
  • 2) You perform a search to narrow down what you would like to invest in based on geographic location, investment minimum, and the business type/model.
  • 3) The loan note is issued to you through a separate lending organization (not the broker).
  • 4) The loan is repaid by the individual in the developing country to the lending organization.
  • 5) The lending organization then repays you (including interest) through the brokerage house.

Several of the providers (they are officially classified as brokers and are registered as such) that I have heard about can be found at the links below.

What kind of return can I expect?

Generally, the returns of these investments of pretty low. Currently, a one year loan on Microplace.com is earning a 3% rate of return.

While this is not stellar, I consider it a very good sign for several reasons.

  • First, it is probably a realistic estimate due to the increased risk with this type of investment being counterbalanced by high interest rates charged to the borrowers.
  • Second, and maybe most importantly, it is currently double what I am earning on my online money market savings account (1.4%). So, it is not all that bad when you think about it!

How is the payback reliability of microloans?

As I was investigating this topic today, I was shocked to find out that microloans actually have a 97% successful payback rate.

This is truly an awesome find! I think it is also proof that people are more motivated to do well if they are treated with respect.

By giving poverty stricken individuals a loan (instead of a donation), they are being instilled with responsibility. It is a pretty cool thing!

My experience with microloans


I always like to add a little human element to my postings whenever possible. This helps it keep this blog alive and not be a dry Newsweek article.

Since this was my first ever microloan, I started with a small $20 loan with Microplace.com. I choose this broker because they are supported through eBay / Paypal, two companies I trust.

The loan note was actually issued by the Calvert Foundation. This organization is a non-profit group that issues community (meaning multiple lenders) loans to help fight poverty. Looking at their website, it actually looks like it would be a pretty cool company to work for for finance majors!

The audited financial statement of the Calvert Foundation can be accessed at the link below.

Google Docs – Calvert Foundation – My Microloan Issuer

Details of my loan are as follows:

  • $20
  • Repayment in less than one year (Jan 2011)
  • 3% annual interest

Since I just made the investment, I haven’t received any interest payments to date.
How about you all? Have you made any investments in micrloans? Did you get your money paid back on time?
How was the overall experience? Was it rewarding?
Tomorrow, we will continue with Part 2 of this series, where we will explore how microloans should fit overall in to your Purpose Focused Financial Plan and overall investment strategy.
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Related articles about microloans at several of my favorite personal finance blogs:

Comments

  1. So how did this work out for you

    • Thanks for reading and asking Heidi! Investing in microloans is going well. I am investing about 50 dollars a month in helping poor people in Peru/Chile start up businesses. The return is only modest (as expected), but I am enjoying helping out.

      Do you invest in microloans?
      My recent post Tips on Saving Money for the Future

  2. Betty Scholten says:

    I have invested in two micro-loan NGO's for many years now. Although yield is low, I did not lose any money during the recent financial crisis. And, I feel my money is being used for a good purpose. I did not go through a broker but did some research on my own and just decided to “jump off the cliff”. I've been very happy with the results

    • Thanks so much for sharing Betty! What area of the world did you invest the microloans in? Also, so you didn’t go through Microplace or another broker? I didn’t know you could directly invest with the loan issuers!
      My recent post How To Save Money When Moving House

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