Wednesday, February 24, 2010

Micro Lending vs. Pay Day Loans

Take a drive down any urban thoroughfare and you will see an abundance of businesses exalting their "pay day is today" mantras. These businesses thrive in low income neighborhoods where individuals are generally living check to check and need some extra cash in between pay checks to make ends meet. You can also find a strong force of these services online, where there has been an uptick in business with the recent economic downturn.

If you have been fortunate enough not to have needed such a service here's how they work. You go into one of these store fronts (or apply online) and provide a recent pay stub and a recent bank statement. Based on how much you earn every pay period, you are then approved for a certain amount- generally not to exceed $500.00. Once approved you write the company a personal check for the amount you were approved, plus the interest fee (more on that later). This check is then held for collateral until you repay the debt. The repayment periods are usually about 2 -4 weeks (to coincide with your pay frequency).

This sounds like an ideal service for those who need it right? Wrong! These companies may not offer credit checks, which make their services widely accessible, but they do lend this money at exorbitant interest rates. The price associated with not having your credit run, is generally an annual percentage rate of about 300-400%. This means that the customer is paying so much in fees that they almost have to take out another loan to cover the hit they have taken to their monthly or bi-weekly budget. As a result a vicious cycle is created and the lenders have a cache of return patrons.

This for-profit service is vastly different from the social enterprise of micro lending. The patrons of a micro lending service are looking to secure small amounts of money to start a business of some sort. In the United States many of the persons interested in this service live below the poverty line and do not posses credit scores that would make them eligible for a conventional business loan. With a micro loan- their business ideas can be realized.

Unlike pay day loans, which only offer a financial trapto its customers; micro financing services usually come with education and training in addition to the funds. Those who receive the loans receive training on how to spend and allocate the funds to make the most of their proposed venture. In the New York City social venture Project Enterprise, local residents with poor credit submit a business plan along with their application for loans requesting amounts ranging from $750-12,000. In addition to the funds, the applicant receives business training, and network opportunities.

Socialinnovations such as Project Enterprise fill a much needed void in the economic community that does not come with the cyclical borrowing of pay day loan institutions. Pay day lenders seem to capitalize off the low income community in which they do business, while micro financing offers the opportunity for residents to reach above the poverty line and enhance their community. Micro lenders also do not adhere to the stringent repayment guidelines of most pay day lenders; allowing their recipients a repayment schedule of 1-2 years.

As the economy continues to be halted by the current financial crisis, lending to small businesses has come to an almost complete stop. Without an almost perfect credit score, those with desires to start their own business are finding their American Dream to be almost impossible. Micro lending provides a valued service and allows opportunities in communities where traditional lending practices are virtually nonexistent.

What do you think?

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