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Is Microfinance for You? Here's how a $25 loan can change the world. (But do your homework before investing.)

By Melinda Fulmer

Opinions expressed by Entrepreneur contributors are their own.

The appeal of microfinance is simple: Give a budding entrepreneur in a developing country a "hand up" to the middle class with a small loan rather than a handout.

This investment appeals to the right as well as the left with its message of encouragement and self-sufficiency. Microfinance also gives investors lending the money -- whether it's $25 or $250 -- a feeling of connection to those stocking their shop, paying for a child's education, or buying feed or seed for a farm.

"It is much more empowering than a philanthropic contribution," says Beth Kuenstler, vice president of marketing for Kiva, one of the largest microfinance sites. In some cases, lenders can even earn a small return on their do-gooding loan.

As with any other charity or investment, however, it's important to do some due diligence first to understand the risks you and your borrowers incur.

Be sure to ask about the interest rates being charged to people who borrow money. "Some of the institutions you can lend through charge [interest] rates upward of 60 percent" on loans, says David Roodman, senior fellow at the Center for Global Development and author of Due Diligence: An Impertinent Inquiry into Microfinance.

Microlending also doesn't reach the poorest of the poor, a point that Kuenstler, a past director of anti-poverty organization CARE, acknowledges. So it's not a substitute for charitable giving.

Here's a look at a few of the top microfinance sites -- how they work, who they help, and what you can expect when making one of these investments:

1. Kiva

Launched in 2005, Kiva has loaned $302 million to more than 760,000 borrowers in 60 countries from Costa Rica to the Philippines. Consumers can click on a loan they'd like to fund -- from an individual or group trying to buy livestock to someone trying to put a new roof on a house.

After browsing, you click to add a loan of $25 or more to a cart and checkout with a credit card or via a PayPal account. When the loan is repaid, those funds are credited back to your account without interest to be used on another entrepreneur's loan, or those funds can be withdrawn using PayPal.

A few things worth noting: Just because you click to fund an earnest-looking farmer in Ecuador for a year, it doesn't mean that your money is going directly to that person. Kiva's microfinance field partners actually make the loans first, and then backfill their general funds with money obtained from Kiva. Lenders do bear the risk of default if the borrower they choose for investment doesn't repay his loan. However, the risk of that is low, given Kiva's 98.7 percent repayment rate.

Another thing that's not so obvious: Kiva's field partners charge interest and fees on that loan you're making -- the average annual yield is 35.13 percent -- so that $1,000 loan might cost the borrower $1,350 or more. That's high compared to U.S. standards, but fairly typical for microlenders in developing countries, Roodman says.

Kiva's fellows do spot checks on partner lenders, Kuenstler says, and award badges on the site for strengths such as providing financial training. More about these ratings can be found here.

2. Zidisha

This 2-year-old microlending site, named for the Swahili word for "grow" or "expand," is a bit different from Kiva in that it pairs lenders directly with borrowers in Africa and Indonesia. There is no intermediary making these loans to business owners. Zidisha has funded more than 300 loans worth more than $186,000 to date.

A prospective lender peruses the site's borrowers, who have been vetted by Zidisha's mostly volunteer staff. Once you choose a loan candidate, such as a tailor in Senegal or a farmer in Kenya, you propose a loan of any size, as well as an interest rate. If the borrower agrees, the loan is funded via PayPal, check or credit card.

The money is sent directly to the borrower, usually via mobile payment, and can be used to open cash accounts, as many borrowers don't have savings accounts, says Julia Kurnia, director of Zidisha.

The photo above shows a man from the Masai tribe in southern Kenya holding the mobile device used to transfer funds to borrowers, enabling him to access his loans without having to leave his village. "This sort of thing wasn't possible even five years ago," Kurnia says. "It's a fantastic example of how technology is 'flattening the world,' making geography less of a disadvantage for people in developing countries than it used to be."

These loans are repaid in monthly installments, and that money can be reinvested in other loans or withdrawn.

Because there is no intermediary in charge of the loan, the cost of borrowing is much less than with other microfinance sites. The average interest rate accepted by borrowers on these 10- to 12-month loans is 3.02 percent, Kurnia says, although many lenders opt to charge less. Zidisha's repayment rate is 97 percent.

3. Microplace

Like Zidisha, this unit of PayPal allows its "investors" to fund global businesses and earn interest in the process. "With Microplace, you earn interest on your original loan and can reinvest the interest so the good you do actually grows," says Giles Cassels, Microplace's head of marketing.

As with a brokerage account, those who fund a project receive quarterly interest payments on investments of $20 or more and quarterly statements until their loan matures and is repaid. The interest rate for each investment is listed clearly, and a prospectus is available for each microfinance borrower.

As with Kiva, although pictures of struggling entrepreneurs are listed on each group's site, you aren't directly investing your money with that person, but filling a general fund used to lend money to the working poor in an area. The annual interest rate that these groups charge their borrowers averages 35 percent, according to Cassels, with most loans ranging from 6 months to four years.

One bright spot with Microplace: Despite funding more than $46 million from 12,000 investors since its inception in 2007, it has never had a default from one of its borrowing groups.

More options: Other popular microfinance sites include United Prosperity, which uses consumer funds to make loan guarantees, and Wokai, a site that specializes in funding impoverished entrepreneurs in rural China.

While microfinance sites are a good way to help established business owners gain access to money to grow their businesses, it's not a total solution to helping the poor, Roodman says.

"We don't have clear evidence that microcredit is reducing poverty," he says. In some cases, it is burdensome, he says, and keeps local lenders from focusing on less-profitable community banking offerings such as savings accounts and money transfers.

Microlending does, however, give those just beginning to climb the economic ladder a better shot at reaching the next rung.

"We aim to give people more options for being self-sufficient and self-sustaining and realizing their dreams," Kuenstler says.

SecondAct contributor Melinda Fulmer writes regularly about issues of health and wealth for publications such as the Los Angeles Times and web portal MSN.

Read more: Impact Investing Goes Small Time

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