What Is Microlending?

What Is Microlending?

Microlending is the practice of issuing small "micro" loans. The amount is usually no greater than $50,000. This type of small business loan is typically issued by nonprofit organizations, and some come with additional resources like mentoring and networking assistance. Some for-profit online lenders also offer micro business loans, but interest rates tend to be much higher—sometimes exceeding 50%. Microloans generally have rates ranging from 0% to 18.99%.

Qualifying for traditional financing can be difficult if you're an entrepreneur who doesn't have the collateral, business revenue or credit history to qualify for a regular small business loan. It can also be difficult to find small business loans that are on the smaller side. Microlending can help bridge that funding gap. The average microloan issued under the U.S. Small Business Administration's Microloan Program is around $13,000.

How Does Microlending Work?

Here's a closer look at how microlending works, from the application process to funding. Just be aware that the process can vary greatly from one lender to the next.

1. Application

After comparing microlenders (more on this below), the first step is to complete an application. Every lender has its own eligibility requirements, but be prepared to provide:

• A business plan
• Previous personal and business tax returns
• Business bank statements
• Business formation documents
• Proof that your business is licensed to operate
• How you plan to use the loan proceeds

Your personal credit will likely be a key factor. However, credit requirements tend to be more lenient for microloans that are offered through nonprofit organizations and community development financial institutions (CDFIs), which serve economically disadvantaged communities. And in some cases, there may be no credit requirement at all.

2. Approval

As a condition of your approval, your microlender may require you to participate in business counseling to receive funding. This is to help increase the chances of you being successful, which reduces their risk. That might look like:

• Financial education workshops
• Peer support
• Networking opportunities
• Finance tools and templates

If you are approved for a microloan, approval and funding times will vary and may take longer if collateral is required or the underwriting team needs additional information from you. Some lenders may approve your application after several weeks of you completing certain onboarding requirements. With an SBA microloan, it may take up to 90 days to get approved.

3. Funding

Your microloan might be disbursed in a single lump-sum payment or gradually in phases. You may also become eligible for larger business loans after satisfying your lender's requirements and successfully repaying your first microloan as promised. Interest rates vary, but rates for loans issued through the SBA microloan program generally range from 8% to 13%. However, that number could be higher or lower depending on the lender.

4. Repayment

Your repayment details will depend on your lender, but microloans are known for their short repayment terms. That might be as soon as six months. The longest term for an SBA microloan is seven years.

Who Uses Microloans?

Microloans are typically geared toward small business owners who are having a hard time qualifying for a small business loan from a traditional bank. They're often used by:

• Startups and early-stage businesses: Entrepreneurs in this camp may have a great concept and a strong business plan, but aren't generating reliable revenue yet. That can make it very difficult to secure a traditional small business loan.
• Underbanked and low-income entrepreneurs: Underbanked often means having a checking or savings account, but also relying on alternative financial services like check cashing services and payday loans. Microloans can be a game-changer for low-income entrepreneurs who are ready to grow but lack the resources.
• Minority entrepreneurs: Many microlenders are mission-based organizations that support minority founders.

Microloan Requirements for Businesses

Every lender is different, but below are some common microloan requirements for business owners:

• Location: Some microlenders only serve entrepreneurs who are located or operate in certain areas.
• Business type: For SBA microloans, borrowers must operate a for-profit small business that meets SBA size requirements. Certain businesses, like life insurance companies and finance companies, are not eligible for SBA loans.
• Loan use: You can use SBA microloan funds to cover working capital, inventory, supplies, furniture, equipment and more. However, the money cannot be used to buy real estate or pay off existing debt.
• Credit score: Credit requirements are set by individual lenders and can range anywhere from 575 to 650 or higher. In some cases, however, it may be possible to get a microloan with no credit check.

Learn more: How to Get a Business Loan

Microlending Platforms and Programs

If a microloan sounds like the right financing option for your small business, you can start comparing lenders, loan terms and interest rates. The SBA maintains a database of authorized intermediate lenders that you can filter by state. If you prefer a CDFI, be sure to check at the state or local level for programs in your area.

Pros and Cons of Microlending

Like any type of small business loan, microloans have important benefits and drawbacks to consider.

How to Get Started With Microlending

Locking in a microloan is a fairly straightforward process, though it varies by lender. Be sure to put these action items on your list before applying.

1. Write a detailed business plan. You'll want to include your product or service description, market analysis, operation plan and financial projections. That can help show lenders that you're a serious business owner who'll use their loan funds wisely.
2. Determine how much money you need. Refer to your business plan, then consider any other sources of capital you may have. That may be your own cash savings, personal loans or lines of credit, and capital from investors. Doing this can prevent you from borrowing more than you need, which could lead to business debt.
3. Check your credit score. If you're just starting out and don't have a business credit score, microlenders will consider your personal credit history. Every lender has their own credit requirements, but a stronger score could help you secure a more favorable loan rate or term. In some cases, your credit score could make or break your eligibility.
4. Think about what assets you might use as collateral. If your microlender requires collateral, you could use business equipment or accounts receivable to secure the loan. Personal assets are another option, but you risk losing them if you default on your loan.
5. Compare lenders. Shopping around and comparing interest rates, borrowing limits, loan terms and borrower reviews can help you find the best microlender for your needs.

Microloan Funding Alternatives for Small Businesses

Small business owners have other funding options. If a microloan isn't for you, compare the following alternatives.

• Peer-to-peer (P2P) lending: P2P lending platforms can match entrepreneurs with individuals who are interested in extending a loan. You'll complete an online loan application and get preapproved, which typically results in a soft credit inquiry. The P2P platform then generates a loan offer and acts as an intermediary between the borrower and the lender.
• A personal loan: This is an unsecured installment loan that you use to fund your business needs. A personal loan can be a good option if you have strong credit. Otherwise, interest rates can be as high as 35.99%.
• Other nonprofit organizations: The Local Initiatives Support Corporation (LISC), for example, offers financing to minority business owners from underserved communities.
• Grants: Grants can unlock free money that doesn't have to be repaid. You can find them through government agencies, community organizations and large corporations. Many grants are designed for business owners who can't access traditional business financing. Visit Grants.gov to learn more.
• Crowdfunding: Platforms like GoFundMe, Kickstarter and Indiegogo are popular crowdfunding sites for funding a small business. But this might involve trading product samples or other rewards in return. You can also explore sites like StartEngine, which give investors a slice of equity in the company. But that means you'll reduce your ownership stake in your business.

Your local SCORE or Small Business Development Center (SBDC) office might also direct you to other financing options in your community.

Frequently Asked Questions

The Bottom Line

Microlending can provide funding to business owners who don't qualify for traditional financing. These types of loans typically have looser eligibility requirements and might come with other borrower resources. However, some microloans require collateral or a personal guarantee, which could put your financial health at risk.

In most cases, your credit score will be a key factor when applying for a business loan. A strong score can help you qualify for the best rates and loan terms. You can get your FICO^® Score^Θ and credit report for free from Experian to see where you stand.