Normally, banks make loans to customers who need a large sum of money immediately to purchase a house or a car or to start a business. These customers are attractive to the banks because they promise to repay their loans with a significant amount of interest.

A microloan is a very small loan for individuals or entrepreneurs – often those living in poverty – who aren’t as attractive to traditional large financial institutions. Banks decide whether they want to lend money based on how likely they are to make a profit by doing so. Things they consider to make their decision are the size of the loan, interest rate charged, and the borrower’s credit quality (or the risk involved in lending to a specific person).

Microloans are available in the U.S., but they’re even more popular in developing nations with a high poverty rate. The average size of a microloan secured through the U.S. Small Business Administration is $13,000. The size of an average microloan worldwide is $1,026. To make up for the higher risk involved in lending to people who may not be able to pay back their loan, microloans often have a much higher interest rate than traditional loans. Interest rates on commercial loans in the U.S. are typically around 7-8%, but they can be more than 20% on micro-loans!

Still, microloans are important to the development of a struggling economy. They are sometimes the only opportunity a poor entrepreneur has to raise enough money to start up a potentially successful business.

Tags: development, loans, microloans