How Does a Micro Loan Work?

What is a Micro Loan? 

A micro loan is not like a traditional loan that requires credit approval and receives funding from a bank. Rather it is a small loan issued by individuals (or a group of individuals) to another person or small business that is trying to put a business plan into action. You might hear the term peer-to-peer lending when referring to micro lending.

A micro loan is considered an unsecured loan in that it is not backed by collateral. While repayment falls in line with a standard loan, paying back principal plus interest, the interest rate for a micro loan will tend to be higher due to the risky nature of this type of lending.

peer to peer micro loan

Why is a Micro Loan Risky?

Micro loans are considered high-risk investments for the lenders. Why? Well, oftentimes a micro loan is given to individuals in countries where traditional lending is unavailable. Other times, people who have bad credit may look to a micro loan for alternative funding. And sometimes, borrowers may want/need a smaller loan amount than a bank is willing to lend. In all these cases, the individual’s proven track record with repayment is unknown, therefore making the investment risky to lenders. Since a micro loan does not require collateral, if a borrower defaults, then the lender will have no recourse for compensation.

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Learn more about Business Loans. Check out our Business Loan Buyer’s Guide.

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