Microloans: What They Are & Where To Apply
Tom has 15 years of experience helping small businesses evaluate financing and banking options. He shares this expertise in Fit Small Business’s financing and banking content.
This article is part of a larger series on Business Financing.
A microloan is a small loan, generally up to $50,000, made to startups and emerging small businesses for working capital or the purchase of equipment. These loans are offered by nonprofit organizations known as microlenders, which have a mission to support economic development in a geographic area or for a demographic group. Microloans typically have repayment terms of up to six years and offer favorable interest rates that are lower than those available through online lenders.
Who a Microloan Is Right For
Microloan programs are geared toward new and small businesses and, therefore, have more lenient qualification requirements. The specific eligibility requirements for these loans vary by lender and may be based on business type, the amount you need, or the age of your business.
Some business categories that microloans may be a good financing option for include:
- Startups and emerging businesses: Many startup businesses have difficulty meeting the qualifications required for a small business loan, making it difficult to receive the initial seed money needed to get a new business up and running. These emerging businesses may benefit from the relaxed qualification requirements offered by microlenders.
- Businesses unable to obtain traditional bank financing: A microloan may be right for your business if you’re currently unable to receive traditional financing. Traditional business loans typically require an excellent credit score and a strong track record for your business, both of which can be obstacles for entrepreneurs and startup businesses. You can use the microloan funds to grow your business while you build your business’s credit history, opening up more funding options in the future.
- Businesses in need of a smaller amount of funds: Traditional lenders often aren’t interested in making low-dollar business loans due to the administrative burden of underwriting smaller loans in comparison to the gains recognized by the bank. As a startup or emerging small business, you may not be seeking a large loan. Additionally, you may not currently have sufficient cash flow to afford the debt payments on a larger loan.
Where To Get a Microloan
Before applying for a microloan, you should shop around and see what different microlenders require and offer. Some microlenders lend nationwide while others specialize in particular geographic areas, types of businesses, or loan sizes. The Small Business Administration (SBA) maintains a list of microlenders in each state that offer SBA microloans, many of which also offer non-SBA microloans, making the SBA’s list a good starting point to find microlenders in your area. It’s worth noting that the SBA approved at least $60 million per year in microloans each of the last several years.
Each lender will have its own requirements and process for loan applications. You’ll need to be aware of the lender’s specific requirements to avoid submitting an incomplete application. Doing some research upfront can save you from spending a lot of time applying to lenders that aren’t a good fit for you.
Qualifying for a Microloan
Qualifying for a microloan is somewhat easier than qualifying for a traditional business loan. When applying for a microloan, you’ll need to provide some basic financial information about yourself and your business. This will likely include documentation of your personal income as well as information about any unpaid debts you or your business have. This information will be used to determine if your business has enough cash flow to cover the payments on the loan you’re asking for.
Microlenders will also want to learn about you and your goals, taking that information into consideration when evaluating your loan application. Many microlenders will require businesses to submit a business plan with their loan application that includes this information. This is one of the biggest differences between microlenders and many traditional lenders; microlenders put additional consideration into your character as a business person, not just your credit score. Your credit score will still have some influence on a lender’s decision, and a FICO score of at least 600 will often be the minimum for most microlenders.
In addition to your business meeting the qualification factors, the intended use of your loan will also be considered. Microloans can be used to purchase or lease equipment, for office space or furniture, for machinery or technology needs, and even for working business capital. Some lenders restrict the use of loan funds. For example, SBA microloans can’t be used to purchase real estate or refinance debt. You’ll need to discuss with your lender whether there are any restrictions on the use of your loan.
After submitting your application, you may be contacted by the lender requesting that you submit other documentation to support your application. The lender may also ask to inspect your office or storefront to ensure that it’s legitimate. Additionally, your lender may require collateral to back the loan, which will have to be assessed to ensure its value. This process can extend the timeline of the application process. Your lender should be able to provide you with an estimated timeline for your application, but most microlenders will reach a decision within 90 days (often much sooner).
Microloan Rates & Terms
The typical rates and terms you can expect with a microloan are:
- Interest rate: 6% to 15%
- Repayment schedule: Monthly
- Repayment term: Up to 6 years
- Restrictions on use of the funds: Determined by the microlender
The specific repayment terms will depend on how much you’re borrowing, the loan’s intended purpose, the lender’s own requirements, and your personal and business financial history. Regardless of the terms you receive, you should read the loan agreement carefully and make sure you understand everything about the microloan before you accept it.
Pros & Cons of Microloans
There are benefits and drawbacks to microloans. While these loans are easier to qualify for than traditional business loans, they’re only available in smaller amounts, and eligibility will vary by microlender.
| PROS | CONS |
|---|---|
| Easier qualification standards | Eligibility can vary by microlender |
| Available to startup businesses | Interest rates are higher than traditional loans |
| Character is a stronger consideration than credit score | Loan approvals can take several weeks |
| More lender flexibility with negotiation on terms and possibly interest rate | Many microloans are capped at $50,000 |
Bottom Line
Microloans are offered in amounts up to $50,000 with repayment terms of up to six years. Interest rates are generally lower than other small business financing options for newer and smaller businesses. Loans can be obtained through microlenders nationwide. One significant advantage of these loans is that they’re accessible to startups and emerging small businesses that don’t have access to financing elsewhere.
