For many small or new businesses without an established financial history, qualifying for a traditional business loan can be difficult. A relatively small amount of funds can make a major difference in helping these businesses succeed, but banks are less likely to lend small amounts. Microloans can step in to provide capital in small amounts to businesses that would otherwise have difficulty obtaining loans or credit.
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What is a microloan?
A microloan is a small, short-term loan for amounts ranging from hundreds of dollars up to $50,000. Microloans are often used by small businesses with few employees, new startups, and sole proprietors to provide necessary funding.
Small businesses may struggle to obtain traditional business loans as banks typically require borrowers to have valuable assets or property to use as collateral, strong credit scores, and established financials. Banks also generally prefer to loan larger amounts, as smaller loans are less profitable. Microloans are an alternative that can provide lower amounts of funding to small businesses and entrepreneurs with limited access to traditional loans.
How do microloans work?
Microloans work similarly to a standard business term loan: The borrower receives the full amount of the loan in a lump sum, then pays it back with interest over time. Typically, microloan repayment terms are up to six years. Funds can be used for many business purposes, including inventory, supplies, equipment, machinery, furniture, payroll, and working capital.
Microloans are typically provided by nonprofit organizations, alternative lenders, or individuals. Some microloan programs are open to all business owners, while others focus on lending to underrepresented groups. Microloan programs may also offer mentorship, training, and other resources to help businesses succeed.
Interest rates can range from six to 30 percent, depending on the lender’s policies and the borrower’s credit. Government and nonprofit microlending programs are more likely to have favorable interest rates and loan terms. Many microlenders will require you to provide collateral—assets that could be repossessed if you fail to pay off the loan—or a personal guarantee.
What are the requirements to obtain a microloan?
As with other types of loans, lenders will evaluate your business and personal credit scores, financial history, revenue, length of time in business, and the funding amount you are seeking. Because microlenders are willing to lend to businesses that are newer or have less established finances, your business plan and goals for how you will use the funds are a key aspect of your application. You will need to demonstrate that the loan will help your business grow and that you will have a strong ability to repay.
Once you have determined how much money you are seeking and how it will be used, it’s a good idea to start by looking for microloan providers based in your area, as many microloans are provided by local or regional organizations. Your city or state may also have resources for business owners.
Where can you obtain a microloan?
Microloans are available from a number of organizations. In our annual evaluation of the best small business loans, we selected Accion Opportunity Fund as our best lender for microloans.
Below, we’ve highlighted some of the major providers:
The U.S. Small Business Administration is one of the largest sources of microloans. The organization distributes funds to local nonprofit lenders, who use these funds to provide microloans to small businesses. Nonprofit lenders each have their own individual requirements for who is eligible to receive microloans. Commonly, collateral and a personal guarantee are required.
The maximum SBA microloan amount is $50,000, but the average loan is around $13,000. Repayment terms are up to six years. SBA loans place some restrictions on borrowers: Funds cannot be used to fund real estate purchases or debt refinancing.
In addition to funding, the SBA can provide resources and assistance in creating a business plan and preparing a loan application.
USDA Farm Service Agency Microloans
The Farm Service Agency’s microloan program is open to new and non-traditional farm businesses, such as those participating in community-supported agriculture, selling through farmers’ markets, restaurants, and grocery stores, or using non-traditional growing methods. The maximum loan amount is $50,000. The program does not consider credit scores, and applicants with no credit history can still be considered.
Kiva is a nonprofit organization that offers loans of up to $10,000 and does not charge interest. To receive a loan from Kiva, businesses must first have obtained loans from family and friends in their communities. After a business is approved, Kiva’s lenders can choose to direct their funds to that business through Kiva’s website.
Grameen America is designed to assist economically disadvantaged women. The program asks women to join in groups of five. After receiving financial education, the women receive loans to start their company. Grameen America provides small loans of $2,000 to $15,000 to its members.
As well as providing SBA loans, LiftFund offers microloans in Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, Missouri, Mississippi, New York, New Mexico, Oklahoma, South Carolina, Tennessee, and Texas. The organization will work with entrepreneurs that have limited credit history, lack collateral, or are not highly experienced.
Accion Opportunity Fund
In 2020, Accion U.S. Network, a nationwide microfinance nonprofit, combined with another nonprofit lender, Opportunity Fund. The organization offers microloans of $5,000 and up. Businesses must have been operating for at least 12 months and must generate $50,000 or more in annual sales. Repayment terms can be customized, and the organization will consider businesses with low credit scores. Business coaching and mentoring are available.
Justine Petersen is an organization that offers a number of microloan options, including SBA microloans, CDFI microloans, and USDA micro-enterprise loans. Business owners can also gain access to credit score counseling, credit building loans, and secured credit cards when they apply for a loan with Justine Petersen.
What are the advantages of microloans?
Microloans have a number of advantages:
- They are easier to qualify for. Compared to other business loans, the requirements to qualify for a microloan are less strict. New businesses and those without an extensive credit history can still qualify.
- They offer smaller amounts of funds. Smaller loans are more manageable to pay back, ensuring that businesses don’t borrow more than they need and become overwhelmed with large monthly payments.
- They are flexible. Although lenders may place some restrictions on what funds can be used for, these loans can be used for a wide range of business purposes.
- They can help establish business credit. If your lender reports to the credit agencies, paying off your microloan on time will help you establish business credit, which can help you get other loans or lines of credit in the future.
- Lenders may offer training or mentorship. Training programs and other resources can provide valuable support to help business owners succeed.
What are the disadvantages of microloans?
Microloans are not right for every business. Here are some potential disadvantages:
- Loan amounts are low. Microloans are generally not greater than $50,000, and many are less than that—the SBA’s average microloan is around $13,000, for example. Businesses that require large amounts of capital will need to pursue other loan options.
- They may have a lengthy application process. Microlenders may require a large amount of documentation as part of their application process, and it can take time to be approved.
- Interest rates can be high. Although interest rates are typically lower than a business credit card, they are often higher than other business loans.
- Training may be required. Some microloan lenders may require you to participate in mandatory training programs. If training is not relevant to your business, this could take up valuable time.
- Not everyone is eligible. Although microloans are easier to qualify for than other types of loans, a low credit score or other financial issues, such as past bankruptcy or unpaid tax bills, may still disqualify you. Lenders may require your revenue or number of employees to be under certain thresholds.
There are a variety of loan options and lenders in the market, and it may be difficult sorting through all of the options. AdvisorSmith analyzed over 30 different lenders and determined the top lenders for small businesses. To determine the best lenders, AdvisorSmith considered a number of factors, including financial strength ratings, customer satisfaction data, complaint ratings from the Better Business Bureau, available terms and loan amounts, and availability of information and ease of use of the lender websites.
|National Business Capital||Overall||National Business Capital is a financing marketplace that specializes in connecting small businesses with a variety of loan products and over 75 lenders.|
|Rapid Finance||Short-term Loans||Rapid Finance is an alternative lender known for offering a variety of short-term loans targeted at small and midsize businesses.|
|Lendio||Startups||Lendio is a financing marketplace that works with a variety of lenders, many of whom offer loans specifically for startups.|
|Fundbox||Lower Credit Scores||Fundbox is an alternative lender that is best known for offering lines of credit and invoice financing for small businesses.|
|Accion Opportunity Fund||Microloans||The Accion Opportunity Fund is a non-profit lender focused on providing funding to small businesses, particularly business owners who are underrepresented minorities and women who may not qualify with other traditional lenders.|
A microloan can be an excellent choice for small businesses that require funds to operate or expand. Microloans can provide funds to companies that might otherwise struggle to qualify for a loan, such as startups, small businesses with limited credit history, and sole entrepreneurs. Although they provide a small amount of funds and are not suitable for companies that require large amounts of capital, microloans are a common, flexible loan option that can assist small companies in many situations.