What is Microfinance? How Micro Loans Work in India

As per RBI rules, microfinance loans are collateral-free loans provided to households with an annual income of up to ₹3 lakh. Since these loans cater to low-income households, they may offer flexible repayment options and be accessible to people with varying credit histories.

Read on to learn how microfinance loans work in India, how much you can borrow, who can apply, what documents you need and more.

How Do Micro Loans Work?

The exact process of how microloans work varies by bank, loan type and your profile. However, the general process includes the following steps:

1. Apply for a Loan

You apply for a microloan through a bank or apply for a government-backed loan scheme through a participating bank. You submit the required application form, documents and supporting details.

2. Verification and Assessment

The bank checks your repayment capacity using details such as bank statements, income proof, where available, and other required documents. Government-backed loans may require additional checks under the relevant scheme.

3. Loan Offer

Based on its assessment, the bank decides whether to approve your application and determines the loan amount, interest rate, repayment tenure, applicable charges and other terms.

4. Loan Disbursal

If you accept the offer, the bank disburses the loan. It may credit the amount to your bank account or pay the relevant beneficiary directly if the loan finances a specific purchase or expense.

5. Loan Repayment

You repay the loan through monthly EMIs or another repayment method agreed upon with the bank, as specified in the loan terms.

6. Loan Closure

Once you repay the full principal and applicable interest and charges, the bank closes the loan.

What Types of Micro Loans are Available?

Microfinance loans can vary based on the type of activity you want to finance, the lender and the loan type. Ujjivan Small Finance Bank offers microloan options for purposes including agriculture, street vending, craft persons, artisans, small businesses, livestock, and more.

The table below lists the available loan categories, their purposes, loan amounts, repayment tenures, and collateral requirements to help you identify which option suits your needs.

Note: The above details are specific to Ujjivan SFB and may vary based on individual borrower profiles and loan requirements.

Who Can Apply for a Microfinance Loan in India?

To qualify for a microfinance loan under RBI rules, your household’s annual income must be up to ₹3 lakh. You must also meet the following conditions:

• Your household’s total monthly loan repayments, including the repayment for the new loan, must not exceed 50% of your monthly household income
• The bank may assess your income stability and credit history before approving your loan, even if your household income and repayment obligations meet the RBI limits
• Some loans may have additional requirements based on their purpose

How Much Loan Can You Get Through Micro Loans?

Ujjivan Small Finance Bank offers microloans ranging from ₹5,000 to ₹3 lakh across different categories:

• Group Loans: ₹5,000 to ₹1.25 lakh
• Individual Loans: ₹51,000 to ₹3 lakh
• PM SVANidhi: Eligible street vendors can get loans of up to ₹50,000
• PM Vishwakarma: Eligible traditional artisans and craftspeople can get up to ₹1 lakh in the first tranche

What Documents are Required to Get a Micro Loan?

Microloans are collateral-free, so the documentation is often simple. To apply for a micro loan with Ujjivan SFB, you need the following documents:

• PAN card or Form 97
• Identity proof such as Aadhaar card, voter ID, driving licence, or passport
• Updated bank statement for the last six months, not older than 45 days
• Recent photograph of the applicant and co-applicant, if applicable

The bank may ask for additional documents depending on the loan category and purpose.

Do Micro Loans Affect Your Credit Score?

Microloans being collateral-free and having more flexible credit assessment, can lead to the assumption that they do not affect your credit score. However, microloans can be reported to credit bureaus and affect your credit history and score, just like other loans.

Here are a few things to keep in mind:

• You need to repay your microloan on time to maintain a good credit history
• Missing EMIs can lead to additional charges and negatively affect your credit score
• Defaulting on a loan or failing to repay it can damage your credit history and score
• Repaying your loan on time can help improve your credit score over time
• Government-backed loans can also affect your credit score when the bank reports them to credit bureaus

So, even if you take a small, collateral-free or government-backed microloan, make sure you repay it on time.

How Does Microloan Repayment Work?

Microloan repayment includes the principal amount, interest and any applicable charges. However, the repayment terms may differ from those of regular loans.

• You can repay your microloan through monthly EMIs or, where available, weekly or fortnightly instalments
• If you want to prepay or foreclose your microloan, check the applicable RBI rules. Banks cannot charge prepayment penalties on microfinance loans
• For government-backed loans, the scheme may offer benefits such as interest subsidies, which can reduce your borrowing cost
• Repaying your loan on time may make you eligible for a higher loan amount or the next tranche under certain government-backed schemes, subject to the scheme’s eligibility criteria.

What are the Recovery Rules for Micro Loans in India?

The RBI has set rules to ensure banks recover microfinance loans fairly. Here are some key rules borrowers should know:

• Recovery agents cannot use threats, abusive language or harassment to recover loans
• Banks and recovery agents cannot harass your family members, friends or co-workers
• Recovery agents should visit the agreed recovery location
• Recovery agents may visit your home or workplace if the you failed to meet at the agreed location on two or more successive occasions
• You can raise complaints about recovery practices through the bank’s grievance redressal mechanism

You must still repay their loans as agreed. If you face repayment difficulties or harassment from recovery agents, contact your bank to discuss your options or file a complaint.

What Other Services are Provided Under Microfinance?

Apart from loans, banks offer other financial services to help low-income households manage their finances and savings.

• Low-MAB bank accounts to manage finances without maintaining a high minimum balance and avoid minimum balance charges
• Fixed Deposits (FDs) and Recurring Deposits (RDs) to help customers grow their savings
• Digital banking facilities to check account balances, download statements and access other banking services online without visiting a branch for every small requirement

Final Thoughts

Microloans help low-income households access formal credit for small businesses, agriculture and other financial needs. However, microloans are not interest-free. Although they do not require collateral, you are still required to repay the loan on time.

Use an online loan EMI calculator to check how much you can borrow and how much you can afford to repay. 

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