The key is that while most folks talk about microloans for lifting the very very poor out of poverty (think Bayamma and her buffalo), microloans could be the solution for the debt swamped and very very behind on retirement investing American middle class.
If you know them at all, you probably think of microloans as those small amounts donated to help start sustainable projects to alleviate poverty abroad. On an investing sliding scale, you’ve probably slid them over towards “give old couch to secretary’s little brother” or “buy a drink from the kids down the block running an Alex’s lemonade stand.” You probably wouldn’t move them into the “interesting way to diversify retirement savings” side of investing. But your clients might not be thinking of them only as charity. Since they stirred up a buzz, microloans have changed. Here’s a two things to know if your clients start asking about using microloans to diversify their portfolios. The TLDR: it’s all about the self directed IRA.
The first thing to know about microloans is that most of what we hear about them is focused on those who receive them. Growth in microloans isn’t that high necessarily. In the last five years, the number of micro-borrowers (those receiving microloans) has grown about 12%, from 211 to 240 million. While microloans hit the buzz factor because of their promise – empowering people out of global poverty through aggregating small loans – the results weren’t as impressive. The idea of financial inclusion, that is, getting businesses and industries to look more to direct investing in people globally to alleviate poverty was successful. The specific loans at issue, not as much.
Most of what people have thought of concerning microloans goes along the lines of those who invest with Kiva. Take this example from GreenAmerica.org about the recipient of one Kiva loan: “Take Bayamma from India, who received three microloans with the help of Unitus, which worked with local microfinance institution SKS. She went from earning 32 cents a day to generating a stable income for her family, all with loans totaling less than $500. Bayamma used her first loan to buy a buffalo.” Micro-loans really are that small; anything from $25 and up can be lent at interest rates ranging from 1 to 6%. Most folks interested in global poverty relief aren’t thinking about their return on investment.
The second thing to know about microloans, and here’s where it gets interesting, is the flip side: microloans in the U.S. work for the lenders. Sites like Prosper.com can match investors with borrowers – assuming state laws allow – and lenders can choose from traditional investments (aka rainy day funds) and retirement accounts, like IRAs. We’ll get deeper into the IRA below, but for now, the key is that while most folks talk about microloans for lifting the very very poor out of poverty (think Bayamma and her buffalo), microloans could be the solution for the debt swamped and very very behind on retirement investing American middle class.
The main point is that there is a market for microloans for the middle class, both as borrowers and as investors. Focusing again on Prosper (and assuming their numbers are accurately stated), they claim that 969,254 people have gotten loans through them, with assets totaling $16 billion. They also claim 3371 loans made in a single week. There clearly is also a market for those looking for loans. What are they seeking? Mainly debt consolidation loans. Prosper, and sites like it, offer a few categories of loans to borrowers and run credit checks on their applicants, so that investors can choose specific tranches of loans to invest in (A rated, B rated, etc.). Interest rates on the loans vary (by risk group and length of loan), but they range from 2 to 6%, and in length from a few months to a few years. It is higher risk investing, as its not backed by the FDIC. However, just like those Kiva loans, investors can start with a minimum investment of $25. And, like those Kiva loans, they can be relatively short term.
According to Nerd Wallet, CD rates in October of 2019 on minimum investments of $500 to $2500 ranged from 2.3% to 0.5%. None of the interest rates for a minimum investment of $500 nudged above that magic 2.3%. And it’s nearly impossible to find a CD lower than the $500 opening amount. That means people who want to invest but have only a small amount could do so through Microloans, where they might not be able to do so through other areas. This might also mean that those who want to diversify their investments but can’t quite set aside more money from their budgets than the 401(k)/403(b) investments they are making could have an option. This is especially important for those who got started late in retirement investing.
Half of U.S. Households have less than $7000 in savings. And according to Bloomberg News, 43% of America doesn’t have access to a workplace investment plan like a 401(k) or 403(b). In other words, most of the middle class has a need to invest, but may only be able to in small amounts or may need to diversify beyond a 401(k) account so that they can catch up.
And now the flip side, according to Credit Karma, “as of February 2019, the average interest rate on a two-year personal loan from a commercial bank was 10.36%, according to Federal Reserve data.” The average American household has somewhere around $6800 and $15,000 in credit card debt (methodology on studies varies from year to year). According to theStreet.com, “the average interest Americans pay on their cards stands at 16.46%.” That is a lot of debt at a lot of interest.
And the market for microloans, be they housing loans or debt consolidation loans, is sure to rise. As the Wall Street Journal explained: “Median household income…. [w]ithout adjusting for inflation, over the three decades through 2017… [is]up 135%. Average tuition at public four-year colleges... went up 549%,… average per capita personal health-care expenditures rose about 276% over a slightly shorter period, 1990 to 2017,… and average housing prices swelled 188% over those three decades....”
For those who need to boost their investments, whether to catch up from years where they didn’t invest or to make up for a separation or divorce, a microloan could spark some interest. Financial advisors may hear from their clients about using self directed IRAs to accomplish these investment plans. Self Directed IRAs have a large number of rules, including who loans can be made to, and may limit the amounts that can be lent. And not all banks will facilitate self directed IRAs. These potentially risky microloans aren’t for all investors, but they may help some investors and given the potential for consolidating (and getting out from under) credit card debt, they may help a lot of middle class would be borrowers.
Before leaping into the unknown, we recommend a thorough examination of your plan. Because we are experts in the field, we know the marketplace and know what your existing vendor is capable of offering. Through this examination, we can help you optimize the service you receive.
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