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How Microlending Works

        Money | Money & Ethics

The Nuts and Bolts of Microlending
Women in developing nations, like these two entrepreneurs in Cambodia, are commonly the recipients of microloans.
Women in developing nations, like these two entrepreneurs in Cambodia, are commonly the recipients of microloans.
Tim Hall/Getty Images

We've seen what microlending looks like on the ground; an entrepreneur makes an application for a small loan -- typically $100 to $1,500 -- makes repayment on a weekly basis with around 31 percent interest included on the principal. It generally follows the structure of a typical loan.

What happens on the other side of the loan transaction (often on the other side of the world) is slightly different than the traditional model. In the first place, the loan is often made by an individual rather than by a lending institution.

Two models for issuing microloans have emerged in the 21st century: for-profit and non-profit. While some large investment firms have created mutual funds devoted to investment in microlending, microlending is increasingly carried out online through individual lenders. Microlending Web sites serve as aggregators where potential lenders can evaluate the needs and validity of the business plans of potential microloan recipients.

We'll look at as a model for the non-profit microlending Web site. Kiva allows loan applicants from countries like Nicaragua, Lebanon, Tajikistan and Mali to submit profiles of themselves and their businesses. Applicants post the amount needed for their loans in U.S. dollars and include what the money will be spent on -- things like agricultural supplies or purchasing wholesale items for resale. Users on Kiva may contribute as little as $25 to an applicant's requested loan amount. Users contribute until the loan is 100 percent funded.

At this point, the loan will either be issued to the loan applicant or a lending group associated with the site will be reimbursed for the loan it's already issued to the applicant. Microlending Web sites typically use third-party lenders (often local community banks) to actually issue the money to the recipient.

The reasons why a person wants to contribute to a loan will lead him or her to either a for-profit or a nonprofit site. Nonprofit sites like Kiva are populated by people who see microlending as a socially responsible cause; their loans will be repaid, but without interest. Other, for-profit sites have become popular as a way to actually make money; in other words, these companies see microlending as an investment. is emblematic of for-profit microlending Web sites. It follows virtually the same model as Kiva, but it offers individual lenders a bonus for their good deeds: a return on their investment. As one investment writer put it, Microplace offers a fairly high rate of return compared to certificates of deposit (CD) -- as high as 5 percent in some cases. What's more, a 97 percent repayment rate shows that microlending can be a fairly safe investment as well.