Chapter 3a: Loan Products

Business Loans


Small or micro businesses in the US make up more than 80% of all US business according to the Association for Enterprise Opportunity (AEO). Many microenterprises are served by local or national banks to access checking accounts, however, access to a credit line is not so easy for small businesses. Several businesses are indeed, ‘micro’ and need less than $10,000 to get started, to keep operating, or to expand. Most banks provide business loans but don’t offer loans under $50,000 – some banks won’t offer loans below $100,000. Microloans are known in the US as small business loans for up to $50K. The Small Business Administration (SBA), an agency of the Treasury Department, supports microlending through grants and loans to SBA Microloan Intermediaries, nonprofit organizations that offer microloans. The SBA reports the average microloan in the US to be about $13,000.

Microloans are used for working capital, to buy inventory, furniture, and equipment. Terms, interest rates, and fees vary according to the size of the loan, planned use of the funds, requirements and costs of the lender, and needs of the entrepreneur. Lenders set their own lending and credit requirements, however, frequently lenders require some type of collateral as well as the personal guarantee of the business owner.

Student-led organizations have offered microloans to entrepreneurs between $100 and $10,000. Each organization sets its own terms and has its own requirements. See below for examples of microloan products student-led organizations offer.

Organization
Intersect Fund
Capital Good Fund
Elmseed Enterprise Fund
Amount
$400-10,000
$500-5000
$2000-4000
Interest Rate
15% + 5% fee
15%
10%
Collateral
Secured
Unsecured
Unsecured
Terms
6-18 months
12-18 months
12 months
Credit Building
Yes
Yes
No

Consumer LOANS

Microenterprise development serves to help entrepreneurs grow their businesses. Microlending, however, is not limited to business development. Several lending products are created for consumers who are not necessarily entrepreneurs. Not all microlenders offer loans solely for entrepreneurial ventures. Lower-income Americans have wide-ranging credit needs— such as buying a computer, applying for United States citizenship, and personal emergencies —that microlenders can meet. Additionally, sometimes the best first step for an entrepreneur to access a business loan is to work on his personal financial performance to build his own credit.

Consumer loans are regulated differently than business loans in some states and require additional legal considerations. See the Chapter on Legal to read about some of these legal considerations. The benefits of consumer lending, however, are significant. Consumer loans put you in touch with a wider range of organizations and people. In addition, certain loan products can become revenue streams.

Lastly, these types of loans provide an entry point for other products and services. In other words, someone might start out with a citizenship loan then, after paying it off, take a business class or business loan. The more entry points you have the more relationships you can build with clients.

Credit Builder Loans

Credit Builder loans are small consumer loans (approx $300-2000) that can help a client increase her credit score. These ‘step’ loans help build a positive credit relationship with a community lender. Reporting positive payments to the credit bureaus is one technique to help a client increase her credit score and practice making on-time payments. Positive repayment history over 6 months has been shown to improve a client’s score 50-100 points. The success of this technique greatly depends on the client’s previous credit experiences (how much debt, late payments, open accounts, etc) and it is important to remember building credit requires a customized approach for each client.

The Intersect Fund offers a credit builder loan of $600 that helps the client build credit by opening 3 accounts. After a client is approved for this loan, she gets 3 accounts opened. First, a $400 deposit is made to her checking account. This is an installment loan that gets reported to the credit bureaus and that the client pays back to the Intersect Fund. The $200 is an additional installment loan that the client pays back to the Intersect Fund, however, the amount is used to pay the deposit for a Capital One secured credit card that the Intersect Fund opens for the client. The client now has 3 new accounts reflected on her credit report.

About the Credit Builder Loan: Interest Rate: $120 Flat Fee; Term: 12 months; Monthly Payment: $60; Collateral: Unsecured

Citizenship Loan

When the Capital Good Fund was undergoing its research phase, they heard from a lot of community groups—and members—that a significant need among immigrants is financing the roughly $875 cost of applying for US citizenship. Capital Good Fund’s mission is broad enough that this kind of loan product made sense. The Citizenship Loan covers the cost of becoming a US citizen for legal residents of Rhode Island. As citizens, borrowers can participate in the democratic process and push for change at the ballot box. Citizens also gain access to more social services and can petition family members to come to the US. The Capital Good Fund requires no collateral and no minimum credit score from our borrowers. Lending decisions are based on character and ability to repay. Borrowers pay back the loan in twelve installments; the repayment of this loan also helps build a borrower’s credit score.

About the Citizenship Loan: Amount: $875; Fixed Interest Rate: 15%; Loan Term: 1 Year; Credit Building: Yes

Employment Loan

The Community Empowerment Fund(CEF) provides no-interest loans of up to $300 for persons in need of employment or self-employment assistance in the greater Triangle area. CEF loans are meant to directly assist borrowers in acquiring or expanding employment opportunities. This includes, but is not limited to, loans for the purchase of goods, trainings, start-up funds, equipment, tools, uniforms, and transportation costs. Loans are given on the basis of the application process, which includes the following written application and a personal interview. Priority is given to applications which include referrals from social service agencies within the greater Triangle area. Upon approval, a flexible repayment schedule will be worked out according to the client’s financial situation.

Upon entering into a loan with CEF, all borrowers also agree to enter a program. CEF’s program is meant to better enable all borrowers to repay their loan by equipping members with the tools and opportunities needed to succeed. Programmatic requirements include:
  • Group meetings: Borrowers will be paired with other members of the program and required to attend weekly group meetings. Repayments will be made during this scheduled meeting time, and all borrowers in the group will be able to use this time to address any issues with their loan officer and to network with each other.
  • Workshops: To financially empower borrowers beyond the terms of their loan, borrowers will be required to attend financial literacy trainings. Depending on a borrower’s skill set and stated needs, additional workshops may be required (i.e. vocational trainings, computer literacy).
  • Savings program: CEF emphasizes the importance of personal and group savings throughout the loan term. Borrowers will be required to save a percentage of their income throughout the loan term, and will make deposits to their personal savings accounts along with scheduled loan repayments. To ensure that the savings account can become a tool to transitioning out of homelessness, borrowers will have limited access to their personal savings accounts until their loan is fully repaid.

In addition, in order to participate in the program, CEF requires the borrower to deposit a fixed amount of their own funds into savings before the loan is dispersed. This amount will be matched by CEF.

Rehabilitation: In the case that a borrower has a history of substance abuse, mental illness, or alcoholism, CEF will consult with the relevant service provider(s).

NOTE: For all of these requirements, CEF loan officers will work with borrowers on an individual basis to determine appropriate and manageable levels of each requirement.

Additional ideas for consumer loan products:
  • loans that help ex-offenders pay off fines so that they can reinstate their drivers license
  • loans that enable lower–income individuals to invest in energy-efficiency, for instance by covering the purchase and installation of a programmable thermostat
  • alternative payday or emergency loans

Group Lending

A lending circle is a group of individuals who come together to receive a group loan. Lending circles are organized in many different ways and are popular in countries all over the world. The classic group lending model was pioneered by Muhammed Yunus in Bangladesh and is currently being used in the United States by Grameen America. In this model, each member of a lending circle receives a small loan to start or expand a small business. No collateral is required of any member of the lending circle because the group model encourages members to provide peer support to one another. Each borrower is individually responsible for his or her own loan, and Grameen believes the group model provides a social network to promote financial responsibility which leads to higher repayment rates. More information about Gramen's model is available on their website here.

Another group lending model is being deployed by the Mission Asset Fund in San Francisco. Their method has formalized common savings circles and requires each individual to contribute a small amount each month. The collective amount is ‘lent’ to one of the group members. Each month, every member continues to contribute the same amount and another member receives the total until each member has had a chance to receive the loan. The idea is by relying on trust created naturally through community relationships everyone can benefit. There is often a group leader who collects everyone’s contributions on time, keeps them in a safe place, distributes payments, and keeps track of who receives the next distribution. Additionally, Mission Asset Fund reports these loans to the credit bureaus to help their borrowers build credit. Read more about their model on their website here.

Individual versus Peer Lending


Advantages to Peer Lending:
  • Efficiency: Because group lending allows one loan officer to serve many people at one time, it can be a cost-effective delivery model. However, a lot of up-front work has to be done to set up the groups, handle logistics, explain the program to people, recruit clients, and train people in the group model.

  • Social Collateral: Because the poor often lack traditional collateral for securing a loan, group lending creates “social collateral” to ensure high repayment rates. Though group members are not responsible for each other’s loans, there are repercussions if one group member misses a payment. Upon group formation, the group can select the two members that most urgently need the loan; those two members then propose their loan to the group and, if the group approved the loan, the group leader then makes a proposal to the MFI. Once those two members receive their loan, they must make two consecutive loan repayments before anyone else in the group gets a loan; if they miss a payment, no one else can get a loan until they are on time. Once everyone in the group has received a loan, the performance of the other group members affects the extent to which each borrower’s loan ceiling—the maximum amount of money they can borrow—increases in subsequent loan cycles. Creating social collateral, especially in the United States, can be very challenging. It is essential to create consistent rules up-front around attendance and clear criteria for taking out a loan. Even then, loan officers must be vigilant to avoid a weakening of observance of the rules which can lead to poor group attendance, late payments and, eventually, loan defaults.

  • Network of Peer Support: The weekly meetings with the borrowers are an incredible chance to get to know the clients on a deep level and provide far more support than an individual borrower would get. In addition, the borrowers often support one another and develop a tight knit community of people looking to better their lives. Making sure that the weekly meetings are about more than just collecting loan repayments requires that you have a curriculum, staff trained to implement the curriculum and clients that feel it is worth making the trip to the group meeting in order to learn from the weekly lesson.

  • “Outsourcing” your underwriting: One of the most beautiful aspects of group lending is that it allows you to outsource your underwriting to the group members themselves. That is, you rely on the dynamics and rules of the group to ensure that the group will not approve a loan that the borrower will not be able to repay. Of course, the MFI has ultimate say as to whether or not the loan is approved, but because the group does a lot of the initial groundwork the process becomes much more simple for the MFI. This only works well when the dynamics of the group are well-established, the rules are clear and consistently followed, and all participants understand the nature of the group commitment and intend to live up to it.

Disadvantages to Peer Lending:
  • Nuances: Many people have said that group lending cannot work in the United States because we have a more individualized culture. While this is debatable given the diversity in American cities, it is definitely true that group lending is nuanced and only works when done right. In other words, the dynamics within the group, the incentives and just about every other aspect of the group structure must be right.

  • Commitment: Because the group meets once per week, every week throughout the life of the loan, student-led MFIs may struggle to find a loan officer that can attend the group meeting every week of the year. The group structure can break down easily and lead to defaults.

  • Culture: Many people are resistant to the idea of joining a group. In order to overcome this, you have to be very good at explaining the nature of the program and, most importantly, find the right people for the program. We have found that the “right people” are any group of individuals that have a shared, common goal—such as getting out of poverty—or are working on a shared issue—such as learning English or getting off of drugs. Another great way of overcoming the resistance to group lending is to form the groups during a mandatory business-training course during which potential group members get to know one another and their business ideas while also learning more about how to run a business.

The logistics of group lending can, simply put, become a nightmare. Group meetings can easily degenerate into a series of phone calls seeking to discern the whereabouts of missing members. It can be hard for the group members to take a bus, walk or drive to a group meeting in the middle of the day when so much else it going on in their lives and so many things come up--illness, events, emergencies, job interviews, etc.

Individual Lending: Individual lending resembles the kind of lending that banks do, with the obvious difference that the requirements of microlenders are much more flexible. Borrowers go through an individual application process and make repayments individually.

Advantages to Individual Lending:
  • “Light-Touch”: Once the loan is issued, you usually only need to be in touch with the client once a month to see how they are doing and to remind them about their loan payment. What’s more, loan repayments can be handled via an Automated Clearing House (ACH) withdrawal from the borrower’s bank account, making the repayment process much easier.

  • Familiar: If the goal is to empower borrowers to eventually take out bank loans, then individual lending will familiarize them with the process.

  • Easy to explain: Unlike group lending, which is unique, it is easy to explain and market individual loan products to potential clients, funders, etc.

Disadvantages to Individual Lending:
  • Harder to underwrite: the challenge with underwriting individual loans is that it takes a long time to get to know someone that just walks off the street and asks for a loan. And no matter how much time you spend looking at credit reports, budgets, makeshift income statements, there is still always the possibility that the borrower won't repay the loan.

  • No peer support: There is no doubt that individual loans can change a borrower’s life, but nothing is as impactful as the borrower community that group lending creates.

Loan Delivery

Consumer Saving Products

Individual Development Accounts

An Individual Development Account (IDA) is a matched savings account that enables low-income American families to save, build assets, and enter the financial mainstream. IDAs supplement the savings of low-income households with matching funds drawn from a variety of private and public sources. IDAs are set up to help individuals planning to save for home buying, education, or starting a business. Additionally, some IDA programs offer matched savings for retirement, computers, home repairs, and other goals. After the individual reaches agreed upon savings goals, the savings are matched 1 to 1 or 1 to 2 by the IDA provider.
There are many different kinds of IDA programs. Terms for the matched savings often depend on where the funds are from – government backed IDA programs have specific requirements that are less flexible than privately funded programs. IDA programs can be as short as a few months to five years. Generally, participants are allowed to withdraw money as soon as they have reached their savings goal, but each program requirements and terms are different.

Here is an example of a regular IDA:
Betty wants to save to go back to school to get her teaching certificate. She attends a financial education class at a nearby nonprofit and works with a staff member to set up an IDA that will be matched 1 to 1. She plans to save $500. She deposits $50 every month into her checking account with her local credit union and her IDA program deposits a $50 match into a separate account. Betty meets with her IDA program sponsor monthly to receive one-on-one financial coaching and a report of how much she has saved so far (her savings + match + interest). After 10 months she has contributed $500 of her own savings, and her IDA program rewards her success with access to the match account, an additional $500 plus accumulated interest.

Another kind of IDA program is a credit builder IDA. This type of IDA couples an IDA program with a credit builder loan to achieve 2 goals at once: consumer gets advantage of matched savings and builds credit with a credit builder loan.

Here is an example of a Credit Builder IDA:
Dave has a low credit score and wants to take advantage of a matched savings program. Dave receives a credit builder loan for $500 from a local credit union. The credit union deposits the full amount of the loan into a new savings account that Dave cannot withdraw from. Each month, Dave pays back the loan. The credit union reports Dave’s on-time payments to the credit bureaus, which help him to increase his score. After 12 months, Dave has repaid the loan and withdraws the $500 savings.

Community Empowerment Fund Safe Savings Accounts


CEF Safe Savings Accounts make saving easy. Through intentional budgeting and savings they work with clients to help set goals and stick to them. Participants who graduate from CEF’s Opportunity Circles and meet their savings goal receive a match of 10% of their savings. The Match can be used for a housing deposit, a car, school tuition, or extra savings.