The Cost of Microfinancing

By Carina Peng


Did you know that 1 out of every 10 American consumer has no credit score? How do they obtain jobs and healthcare benefits, apartment rentals, and loans? Without a credit score, not only would you not be able to access loans, but you would also encounter many inconveniences in daily life, leaving you out of the financial and social mainstream. It is clear that a student might experience the downsides of the lack of a credit score since they do not yet have experiences building a high score. For example, Tracy Frizzell, the Executive Director of the Economic Awareness Council, said she knows of “students recently that had difficulties renting an apartment because a rental often either requires a good credit score or a high rental deposit.”


Lack of credit also impacts an individual if they want to start a business. This is especially true in countries that do not have an established lending system. However, there is a solution called microfinance, which is the transfer of small amounts of loans to aspiring entrepreneurs who do not have access to normal financial services. Through lending micro-loans to the poorest individuals in the world, microfinance pioneer Mohammed Yunus showed that microfinance has the power to allow these people to bring themselves out of the poverty cycle.


As good as it sounds, however, microfinance is far from a fairy-tale that can alleviate poverty at once. When looking at microfinance from the perspective of a cost-benefit analysis, there is much to be revealed. Since the borrowers often do not have any proof of credit worthiness, the investment is risky. Therefore, to compensate for this, loan companies charge unusually high interest rates. Kiva, a leading micro finance organization that many perceive as philanthropic, in fact charges a 35% interest rate for their poor borrowers.


You may ask, are there any other options for those who do not have any credit or who have low credit scores? Unfortunately, there are not many options. Loan Sharks charge even higher interest rates (average 520% annually) than microfinance lenders, usually under illegal conditions, while payday loans charge a high interest rate (as much as 400% annually) in an agreement that you will pay back when you receive your next paycheck. Dillon Hoover, an analyst at the institutional investment firm Castleark, summarizes the disadvantages of not having a high credit score. “They not only encounter high interest rates and short payback period, but also loan limitations.” Now that you’ve learned about the difficulties faced by the world’s population without credit, it is easier to understand why major international organizations are increasing their effort to encourage everyone to build credit.

©2020 by On the Money Magazine Online

  • Facebook
  • Twitter
  • Instagram