# Microcredit Explained: Definition, Process, and Loan Terms

> **Definition**
>
> Microcredit is a form of microfinance that provides very small loans to low-income individuals to help them start or grow small businesses.

## What Is Microcredit?

Microcredit is a type of [microfinance](https://www.investopedia.com/terms/m/microfinance.asp) where small loans are given to help people start or grow small businesses. These borrowers tend to be low-income individuals, especially from less developed countries (LDCs).

Because many lack collateral or a credit history, borrowers are often bundled together to repay their loans as a group. Microcredit is also known as "microlending" or "microloan."

### Key Takeaways

*   Microcredit provides small loans to impoverished individuals to promote self-employment and small business growth.  
    
*   Originating in Bangladesh, microcredit often uses group lending to minimize risk and improve repayment rates.  
    
*   Microloans usually range from $10 to $2,000, with repayment agreements that might not require traditional collateral.  
    
*   Successful repayment of microloans can lead to access to larger loans, facilitating further economic opportunity.  
    
*   Criticisms include misuse of funds and risk of debt for borrowers with unstable income sources.

## The Mechanics of Microcredit: How It Operates

The concept of microcredit was built on the idea that skilled people in underdeveloped countries, who live outside of traditional banking and monetary systems could gain entry into an economy through the assistance of a small loan. The people to whom such microcredit is offered may live in barter systems where no actual currency is exchanged.

Modern microcredit is typically attributed to the Grameen Bank model, developed by economist [Muhammad Yunus](https://www.investopedia.com/terms/m/muhammad-yunus.asp). This system started in Bangladesh in 1976, with a group of women borrowing $27 to finance the group's own small businesses. The women repaid the loan and were able to sustain the business.

The women in Bangladesh who received microcredit did not have money to purchase the materials they needed to make the bamboo stools that they would, in turn, sell—and at the same time, each individual borrower would be too risky to lend to on their own. By borrowing as a group, the initial financing gave them the resources to begin production, with an understanding that the loan would be paid over time as they brought in revenue.

> **Fast Fact**
>
> Microloans can range from as small as $10 to $100, and rarely exceed $2,000.

The structure of microcredit arrangements frequently differs from traditional banking, wherein collateral may be required or other terms established to guarantee repayment. There might not be a written agreement at all.

In some instances, the microcredit was guaranteed by an agreement with the members of the borrower’s community, who would be expected to compel the borrower to work toward repaying the debt. As borrowers successfully pay off their microcredits, they may become eligible for loans of larger and larger amounts.

## Understanding Micro-Loan Terms and Conditions

Like traditional lenders, micro-financiers charge interest and set specific [repayment](https://www.investopedia.com/terms/r/repayment.asp) plans with regular payments. Some lenders require borrowers to save part of their income as insurance against  [defaults](https://www.investopedia.com/terms/d/default2.asp). If the borrower repays the loan successfully, then they have just accrued extra savings.

Since many borrowers lack collateral, microlenders often pool them together as a buffer. Loan recipients repay their debts together, creating peer pressure that encourages repayment, as the program's success depends on all members.

If someone struggles to start a business, they can seek help from group members or the loan officer. Repaying loans helps recipients build a good [credit history](https://www.investopedia.com/terms/c/credit-history.asp), enabling them to qualify for larger loans later.

Interestingly, although these borrowers often qualify as very poor, repayment amounts on microloans are often actually higher than the average repayment rate on more conventional forms of financing. For example, the microfinancing institution [Opportunity International reported](https://spm.opportunity.org/2016-update) repayment rates of approximately 98.9% in 2016.

## Evaluating the Criticisms of Microcredit

There have been criticisms of microcredit and the way it can be misused. For example, in South Africa, microcredit was introduced in some of the poorest communities to encourage people to pursue [self-employment](https://www.investopedia.com/terms/s/self-employed.asp). However, in some cases, the funds were used for consumption rather than creating or growing businesses or jobs.

Also, the borrowers may find themselves with a magnitude of debt they cannot repay, even with the small-scale loans offered through microcredit. The issue is borrowers might lack steady income or plan to develop income through microcredit to repay loans. As a result, some borrowers have resorted to selling off personal property and seeking new financing to cover their previous microcredit.