Looking for affordable loans and access to bank accounts may not be as easy for some people, especially those of lower income and in rural or underserved areas. That’s where Community Development Financial Institutions, or CDFIs, step in. These organizations aim to serve economically disadvantaged communities.
Here, take a closer look, including:
• What a CDFI is and how they work?
• What are the different types of CDFIs?
• What CDFIs offer?
• Pros and cons of CDFIs.
What is a Community Development Financial Institution?
Community Development Financial Institutions, or CDFIs, are financial institutions — mainly banks and credit unions — that help those in underserved communities in rural and urban areas. CDFIs were established by the Riegle Community Development and Regulatory Improvement Act of 1994. At the same time, a CDFI Fund was formed to assist these institutions in providing loans (business and personal) and other types of financial assistance to those in need.
To promote accessible products and services, CDFIs typically rely less on common factors such as credit scores and monthly fees when providing loans and bank accounts. (For instance, economically disadvantaged people may have trouble opening a standard checking account if they have a low credit rating and typically be given access to a second chance checking account. A CDFI may offer more options.)
CDFIs may also help invest in the local community by providing tools to build credit, encourage savings, and share other financial literacy tools. Currently, there are around 1,000 CDFIs across the U.S.
How Do CDFIs Work?
CDFIs work by providing products that, among other things, offer individuals and businesses the opportunity to borrow funds at a lower cost and to build their credit. The CDFI Fund, part of the U.S. Treasury, allows financial institutions to offer low-cost loans and mortgages for small businesses and first-time home buyers. CDFIs also can offer credit builder loans to help borrowers build a positive credit history.
Here’s an example of how a CDFI might help underserved communities build financial literacy and save money. If a person needs $400 to pay for a car repair, they might not have the cash available and would instead need a loan. Instead of seeking banking alternatives and, say, heading to a payday loan lender that offers a 350% interest rate, a CDFI might offer a loan with a rate of 20%. Doing so can save the borrower a significant amount in interest and contribute to their financial wellbeing.
What Are the Types of CDFIs?
There are several types of CDFIs; they tend to have similar, but not identical, missions. If you want to understand the specifics of what a CDFI is, you’ll find a few options:
Community Development Banks
Community development banks tend to be for-profit organizations that provide loans to those who are in distressed or underserved communities. Most commonly, borrowers are small businesses, non-profit organizations, local entrepreneurs, and housing developers.
Insured through the FDIC, these loans include business and non-profit loans, mortgages or home improvement loans, and some banking services.
Community Development Credit Unions (CDCUs)
CDCUs are financial institutions that are non-profit and member-owned, offering products and services to both business and consumers. Some of these may include credit counseling, consumer banking products like checking and savings accounts, and business planning for lower-income folks who are members of the CDCU. Given that these services are designed for the economically disadvantaged, customers may not have to deal as often with such issues as figuring out why a bank account is frozen and instead get support and financial literacy training.
They might also gain more services, such as being able to wire money to others.
Community Development Loan Funds (CDLFs)
CDLFs are typically funds that work with small businesses, non-profit organizations, and social-service provider facilities in lower-income communities. These mostly non-profit funds tend to provide pre-development, start-up, and business expansion loans at a lower interest rate. Typically, they also offer extra guidance such as help with business planning.
Community Development Venture Capital Funds (CDVC)
CDVCs provide funds, both equity and debt, for medium-sized businesses to encourage them to create jobs and other resources that help benefit lower-income and other types of underserved communities. Borrowers also tend to be businesses with a high potential for growth to which the CDVC will also provide extensive guidance.
Microenterprise Development Loan Fund
This type of loan fund offers loans and assistance, such as technical support, to lower-income entrepreneurs and self-employed individuals who can’t access conventional loans. These funds are usually non-profit and offer a peer lending model.
Community Development Corporations
Community development corporations are non-profit organizations usually formed by the local community and run by a volunteer board. They aim to use funding and investments to revitalize lower-income communities by offering affordable housing, providing social services, and creating jobs.
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Requirements for CDFI Certification
To be eligible for CDFI certification, a financial organization must have a main mission of offering services to lower-income and underserved communities.
Other eligibility requirements include:
• Providing financial and educational support services
• Serving in a minimum of one eligible target market
• Need to direct a minimum of 60% of their services to at least one eligible target market
• Maintaining accountability to their defined eligible target market
• Being a non-governmental and legal entity (except Tribal government entities) when applying for CDFI certification
How Do CDFIs Help People of Lower Income?
These mission-driven financial organizations work specifically to help underserved communities, particularly those who are lower-income. By offering financial services, such as bank accounts and loans, they can elevate the community. Even if funding goes towards businesses, the loan proceeds need to be able to help lower-income communities, whether that’s through job creation or other forms of assistance.
What Do CDFIs Offer to Communities?
CDFIs offers the following products and services to communities:
• Low-interest loans
• Affordable housing opportunities
• Bank accounts for those who may not have access to traditional financial products and services
• Training such as financial literacy and business development assistance
Benefits of CDFIs
Advantages of Community Development Financial Institutions include:
• Access to banking services for those who have been denied by conventional means
• Access to low-interest loans to grow a business or find a more affordable path to homeownership
• Increased access to financial and business training
• Potential growth opportunities in lower-income and other underserved communities
Drawbacks of CDFIs
Disadvantages of Community Development Financial Institutions include:
• Not all areas will have easy access to a CDFI
• May not always be easy to get loans or funding, depending on the borrower
• Interest rates may be higher than conventional loans for creditworthy borrowers
• CDFIs’ ability to provide funds may be limited by investors and the federal government
The Takeaway
Community Development Financial Institutions, or CDFIs, are stepping up to help lower-income and underserved communities access affordable loans and financial products they otherwise may not have. While there are a limited number of CDFIs and funding is not infinite, they are working to improve both funding and financial literacy in some of America’s more vulnerable communities.
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FAQ
What is the difference between a bank and a CDFI?
Banks and CDFIs are both types of financial institutions, though the main difference lies in their mission. Banks tend to be for-profit organizations that focus on satisfying their shareholders by generating profits. CDFIs, on the other hand, aim to provide accessible and affordable financial products and services (such as bank accounts and loans) to lower-income and other underserved communities across the U.S.
How does a bank become a CDFI?
A bank can become a CDFI by getting certified by the U.S. Treasury. It needs to meet certain criteria, such as directing at least 60% of its funds towards financial products and services for lower-income communities, as well as navigating other stringent certification processes.
What are the benefits of being a CDFI?
The benefits of being a CDFI include getting additional training resources, networking opportunities with other financial institutions, and some exemptions to lending caps and mortgage rules. Of course, there’s also the benefit of knowing your organization is helping underserved communities grow and thrive.
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