What Is a Microloan and How Can Your Small Business Benefit?

A microloan is a small loan, generally up to $50,000, made to startups and emerging small businesses. These loans are offered by nonprofit organizations known as microlenders. Microloans typically have repayment terms of up to seven years and offer favorable interest rates that are lower than those available through online lenders.

What Is a Microloan?

A microloan is a financing product aimed at startups and small businesses that are unable to obtain traditional financing. Microloans are offered by community-based nonprofit intermediary lenders and are generally aimed at specific demographics. These loans are generally easier to qualify for than traditional small business loans and often have lower interest rates than traditional business loans.

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How Microloans Work

A microloan is a small business loan ranging from $500 to $50,000 that is provided by an intermediary lender. The intermediary lender, also called the microlender, receives funding from another source, such as a state government or the federal government, at a discounted rate. The microlender then makes loans to small businesses. The small business receives the loan funds, and the loan is repaid over time to the microlender.

Most intermediary lenders are area nonprofit organizations. These organizations often have missions that support economic growth in a certain geographic area or for a specific sector of the population like minority business owners. Often, the qualification requirements set by the microlender are specific to the sector the organization supports or the specific economic needs of a region. For example, if the microlender’s mission is to support a certain minority group, they may require that you are a member of that demographic.

Who a Microloan Is Right For

Microloans are often a good fit for businesses that have trouble getting access to traditional lending. They’re great if your business is very new, and you don’t have a long credit history or if you only need a small loan. If your business needs a small loan, and you don’t have access to a traditional bank loan, a microloan might be a great option for you.

Startup & Emerging Businesses

Many startup businesses have difficulty meeting the qualification requirements to receive 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 Financing

A microloan may be right for your business if you are 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 That Only Need a Small Amount of Funding

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.

Qualifying for a Microloan

It’s generally easier to qualify for a microloan than a traditional business loan. 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.

Microlenders will want to learn about you and your goals and will also consider that information when evaluating your loan application. This is one of the biggest differences between microlending and traditional lending. Microlenders put additional consideration into your character as a business person, not just your credit score.

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 technical needs, and even for working business capital. Some lenders restrict the uses of loan funds; for example, Small Business Administration (SBA) microloans can’t be used to purchase real estate or refinance debt. You’ll need to discuss with your lender whether or not there are any restrictions on the use of your loan.

Microloan Rates & Terms

In general, microloans have lower interest rates than traditional loans, with rates ranging from 5% to 20%. Repayment terms typically range from three months to seven years. Some microlenders have limitations regarding what the loan funds can be used for, so it is crucial to be aware of those restrictions before accepting the loan.

The typical rates and terms you can expect with a microloan are:

• Interest rate: 5% to 20%
• Repayment schedule: Monthly
• Repayment term: 3 months to 7 years
• Restrictions on use of the funds: Determined by the microlender

The specific repayment terms you receive will depend on how much you’re borrowing, the intended purpose of the loan, the lender’s own requirements, and your personal and business financial history. For the most part, terms of a microloan are negotiable with the lender. As the business owner, you know your business better than the lender, so you may be able to convince the lender that you deserve better terms.

Regardless of the terms you receive, you should read the loan agreement carefully and make sure you understand everything about the loan before you accept it. If you have questions about the loan agreement, the lender can explain anything that isn’t clear. Taking on loan debt is a big decision, and you need to be comfortable with the loan terms before you commit. Once you’re approved and sign the closing documents, the money will be deposited in your bank account or sent to you by check.

Where to Get a Microloan

Prior to applying for a microloan, you should shop around and see what different microlenders require and offer. Some microlenders can lend nationwide while others specialize in particular geographic areas, types of businesses, or loan sizes. The 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 source to find microlenders in your area.

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 a lot of time applying for loans with lenders that aren’t a good fit for you.

How to Apply for a Microloan

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.

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.

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 typically involve higher interest rates.

Pros of a Microloan

Some advantages of microloans include:

• Easier to qualify for than traditional financing: Unlike traditional financing that requires excellent credit and an established and proven business, microloans are available to new businesses and those that are building their credit.
• Available to startup businesses: Startup businesses often find it difficult to obtain financing due to lack of financial history, making microloans one of the few options that are available to new businesses.
• You can typically receive funding within 14 days: Traditional bank loans can take more than a month to fund. In general, microloans can be funded in 14 days or less.

Cons of a Microloan

Some disadvantages of microloans include:

• Eligibility and qualification requirements vary by lender: Qualification requirements for a microloan vary from lender to lender, which can make it difficult to know whether or not you qualify.
• Higher interest rates than traditional loans: While microloans offer interest rates that are more affordable than many online small business loans, the rates are still higher than one would receive through a traditional bank lender.
• Limited loan amounts: The maximum microloan amount is $50,000, with the average loan being significantly lower. Businesses needing funding beyond this amount may be better served by an alternative.

Microloan Alternatives

If you are uncertain that a microloan is the right financing option for your small business, there are alternative financing opportunities available. Some alternative financing options include a rollover for business startups, a personal loan for business, a business credit card, or an SBA microloan.

Rollover for Business Startup

One funding alternative to a microloan is a rollover for business startups (ROBS). If you have existing savings in a retirement account, a ROBS allows you to access those funds to start your business. A ROBS is not a loan, meaning there’s no debt to repay or interest payments to make. Another benefit of a ROBS is that you can utilize your retirement savings without paying early withdrawal penalties or taxes on the funds.

Personal Loan for Business

Those that are unable to qualify for a microloan may consider using a personal loan for business instead. A personal business loan allows you to qualify for a loan based on your personal credit and finances, with proceeds going toward your business. Personal loans do not require submission of business plans, can often be applied for online, and some of the best personal loans for business can provide the funding you need within days.

Business Credit Card

If you have recurring working capital needs, a small business credit card can be a relatively cost-effective alternative to a microloan. Many credit cards offer introductory periods at 0% annual percentage rate (APR) as well as cashback or rewards programs. These cashback and rewards incentives can be beneficial if you regularly use credit cards. Having access to a business credit card can be an immediate source of funds for your small business expenses.

SBA Microloan

The SBA offers microloans up to $50,000 for small businesses through intermediary nonprofit lenders. Interest rates for SBA microloans range from 8% to 13%, with terms up to six years. SBA microloans are available to startups and established businesses and provide funding much faster than other SBA loan types.

Microloan Frequently Asked Questions (FAQs)

What are microloans used for?

Microloans are small business loans offered in amounts up to $50,000. Loan funds can be used for working capital, to purchase inventory and supplies, or as financing for furniture, fixtures, equipment, or machinery. SBA microloans cannot be used to purchase real estate or refinance existing debt.

How much is a microloan?

Microloans are small loans offered in amounts that typically range from $500 to $50,000, although the average microloan is roughly $13,000. Exact interest rates and repayment terms vary by microlender, but typical interest rates fall in the range of 5% to 20%, with repayment terms of up to seven years.

How can I get a small loan fast?

There are several online lenders that provide fast business loans. Small business loans through online lenders typically have relaxed qualification requirements compared to traditional lenders. These small business loans are generally offered with short repayment terms and high-interest rates compared to traditional business loans.

How do I get a microloan?

Microloans are offered through nonprofit agencies, referred to as microlenders. Some of the best microlenders offer microloans nationwide while others serve only specific borrower types. To receive a microloan you will need to contact a microlender and complete an application for the loan. If approved, you can typically receive funding within two weeks.

Bottom Line

Microloans are offered in amounts up to $50,000 with repayment terms of up to seven years. Interest rates are generally lower than other small business financing options. Loans can be obtained through microlenders nationwide. One significant advantage to these loans is that they are accessible to startups and emerging small businesses that do not have access to financing elsewhere.