Microfinance vs. Microcredit

People learning about microfinance and microcredit

When people need money, they usually have a variety of loan options available to them, such as personal loans and lines of credit. However, low-income individuals who lack financial resources may have just two options: microfinance vs. microcredit. Both are sources of funding for low-income individuals.

Both concepts serve tens of millions of people, primarily in poor, third-world countries. They can help the poor start businesses, provide for their families, and save money.

What Microfinance Means

Microfinance began in the 1970s when entrepreneurs would lend money to the poor. It was proven that the loans had high repayment rates, and these loans would pull the poor out of poverty. Microfinance isWoman taking out a micro loan

Microfinance includes a variety of activities. A small loan is an example of microfinance. Many of these loans are much smaller than your average loan—$27 to $500. The interest rate on these loans is around 35%, which may seem high, but is lower than the rates charged by loan sharks and other alternatives.

These small sums may not seem like a lot of money to some people, but they can help the poor start a small business and become economically independent. So microfinance does help the poor in many ways.

What Is the Difference Between Microfinance and Microcredit?

Microfinance and microcredit primarily have one thing in common: They look to increase financial resources for individuals and companies that are not eligible for traditional services.

Microfinance Characteristics

Microfinance refers to a broad number of services available to those who are very poor. These individuals may not qualify for the services found in traditional banks. Microfinance has these characteristics:

  • Includes credit and non-credit activities such as pensions, savings, and insurance
  • It helps raise the income of the lower class
  • Allows the poor access to loans and deposits
  • It helps the poor fulfill their basic needs
  • Promotes gender equality
  • Expands financial services to the poor

Microcredit Characteristics

Microcredit refers to a small amount of credit provided to needy people with a low earning capacity who are unemployed and have a little credit history. It has the following characteristics:

  • Includes credit activities
  • Sometimes helps particular groups earn their livelihood (e.g., women in developing countries)
  • Requires no assets for collateral
  • Provides financial assistance
  • Offers small, short-term loans
  • It helps those in rural areas become self-employed

What Are the Advantages of Microfinance?

Microfinance offers many benefits:

  • It helps the poor provide for their families. Microfinance gives families more opportunities. It makes them more resilient and able to rise out of poverty.
  • It extends credit to the poor. Those in poverty have no collateral, so they cannot get credit through traditional means. Microfinance offers small amounts of credit to help stop poverty.
  • It serves minorities. Women, the unemployed, and those with disabilities are underserved in countless communities. Those who receive microloans can take control of their lives.
  • It educates children. Children who live in poverty often have to miss school to work to help their families earn money. When families receive loans, their children have a better opportunity to go to school and get an education.
  • It helps families save money. When people have their basic needs met, they can keep their money for future emergencies. Microloans can help families save for the future.

What Are the Disadvantages of Microfinance?

While microfinance has many benefits, there are some downsides as well:

  • Very small loan amounts. As mentioned above, the loans are for small amounts—under $500 and even under $100. While small loans can help push a family or new business in the right direction, they won’t help with large purchases.
  • Numerous payments. Those who lend the money want to be paid back promptly. This may mean repayment at the weekly level instead of the monthly repayment period required by most loans. This means borrowers need to stay on top of the payments.
  • Restrictions. You can’t use microloans for anything you want. Some lenders have restrictions, such as not buying real estate or paying off other loans.
  • High-interest rates. The operating costs for these small loans mean that lenders need to recoup their losses by charging high-interest rates. Many of the loans have rates of 35% or more, which is higher than a traditional loan.

Learn More with Power Finance Texas

Microfinance strives to help people escape poverty, but financial literacy is crucial to staying afloat. Explore the Power Finance Texas blog to equip yourself with the knowledge you need to budget, save, and spend like an expert!