There are many different loan products on the market and new technology is increasing the variety.
For example peer-to-peer (P2P) technology (the ability of large numbers of people to connect and share data without centralisation) is changing the business world – particularly finance. One area where this is seen is with the emergence of microlending. A microloan or microcredit is a small loan funded by an individual or divided among a group of individuals (commonly through a P2P platform), instead of a bank or lender that operate in a traditional business model.
Microloans are becoming a common philanthropic method of helping people in the third world, who do not typically have access to credit to launch businesses; however there are several microlending platforms serving regular borrowers in the UK, US and other western nations. Just like traditional loans, microloans are issued with interest on top of the principal. Because interest can be quite high (especially when lending to those with poor credit or from poor economies) some people see the concept as high risk, but with high reward.
What makes microlending particularly unique is that it’s up to the individual or community how much they are willing to lend, who they will lend to, and the interest rates charged. People who want to use their savings to make a profit can take part in microlending and adopt as much risk as they feel comfortable with. Using P2P platforms they can easily connect with borrowers who are willing to accept their terms.
Depending on the platform an internal credit score is calculated based on factors such as whether the borrower is a home owner, how much they earn, traditional credit information, and if they have ever successfully or unsuccessfully borrowed a microloan in the past.
Microloans do not require any collateral to secure them, so there may be increased risk for the lender. In turn they can charge slightly higher interest rates, which make it a better investment than the top savings accounts.
However because of P2P technology risk can also be reduced and is usually spread among many lenders. This is accomplished by lenders only investing a small percentage per loan. Those who want to invest a lot build up a portfolio that may contain contributions to hundreds of different microloans. So even if a few loans default, there will still be an overall profit from the portfolio. On the flipside borrowers are therefore indebted to many different individuals (not just one company).
Most microlenders are individuals – some are tech and P2P enthusiasts, others are simply looking for new ways to make their savings go further, and some are professional investors. Most major banks and highstreet lends are not interesting in microlending, so it has truly become a pure decentralised peer-to-peer process.
As mentioned, microloans are commonly issued for two reasons. One is to fund entrepreneurs in third world or developing nations, who want to start a small business but cannot get financing from lenders or the government in their own country. Lenders often take part in this kind of microlending not just to make money, but as a charitable endeavour as well. Similar to a Go Fund Me campaign, borrowers will tell their story, describe the ins and outs of the business they are trying to launch, and the benefits to investors.
Microloans are also issued to people in developed nations who are struggling to obtain credit from traditional sources because they have a bad credit rating, or those who simply want to borrow outside of the established financial system. Similar to payday loans, the amounts are small and ideal for those faced with unforeseen expenses or have gone over their monthly budget and need some cash to tide them over.
Interestingly unlike traditional lending, microlenders often require the borrower to explain what they want to use the money for. Individual lenders on the platform can then decide whether they deem it risky or not. Sometimes requested loans can only be partially funded because not enough lenders were interested.
Despite still being quite obscure, microlending is already a multi-billion pound industry. Platforms make a profit by adding in their own fee on the lender’s side, borrower’s side or both.
Microlending is an innovative new opportunity for both lenders and borrowers, born out of the growing peer-to-peer web-based economy. Individuals looking to make money can get high returns, funding borrowers who struggle with traditional financing due to issues in their country or a bad credit history.
Some lenders may pledge to fund a whole loan if it meets their own requirements, but more often than not it is safe and more desired to spread investment over portfolio of microloans – a diversification of risk.