Microloans are a great option for entrepreneurs who need a small loan that might not qualify with a traditional bank or credit union. They work similar to traditional loans, but there are a few key differences that you need to know. We’ll explain microloans and compare them to traditional loans to help you determine which loan type is right for you.
Table of Contents
- 1 What Is a Microloan?
- 1.1 Microloan vs Traditional Loans
- 2 Micro Business Loans
- 2.1 SBA Microloans
- 3 Personal Microloans
- 4 Microloans as an Investment: Micro Lending for Profit?
What Is a Microloan?
A micro loan is a small business loan no more than $50,000 that is issued by an individual or through an intermediary nonprofit organization. Most microlenders aim to help individual business owners and entrepreneurs get the initial capital they need to cover startup costs, hire their first employee, or purchase the initial inventory they need. Microloans can be funded by a single individual or by a collective group who all contribute a portion of the total loan amount.
Microlending has changed many lives and improved economies, especially in developing countries and among women, minorities, and underserved communities. This form of lending and borrowing is made possible by the internet and modern technology, which allow us to connect people from anywhere in the world, share our stories, and provide opportunities we might not have had available in the past.
A microloan could be as small as $25-$50, which can make a world of difference for someone in a developing country that may just need a food cart to get their business started. But generally, microloans range from $500 up to $50,000. The average microloan amount is around $13,000, according to U.S. small business statistics from the SBA.
Microloan vs Traditional Loans
Microloans and traditional loans basically operate just as any loan would: a lender offers a lump sum on certain terms and the borrower agrees to use the funds as disclosed and pay back the premium plus interest once the loan has matures, or split up into payments over time. However, microloans hold their own category under the small business umbrella. For instance, microloans can be no more than $50,000 and must not be given terms longer than six years.
While microloans are used all over the world, they are most frequently given to people who don’t have access to traditional funding: women, minorities, people with bad credit, and people in developing countries. If you’re interested in a small business loan, consider applying for a traditional loan first because you can qualify for a larger loan over a longer term agreement, and for a lower interest rate.
Interest rates are always subject to change, but the SBA requires interest rates for microloans to generate around 8 to 13 percent which is considerably higher than the interest rate for a small business loan. As of November 2018, the SBA set the maximum interest rate that banks can charge on loans at 5.04% to 5.32%. These interest rates depend on the type of loan you apply for and the amount of the loan. Generally, larger business loans are cheaper than a microloan.
Micro Business Loans
Micro business, or micro enterprise, improves individual lives, families, communities, and economies by providing business opportunities to entrepreneurs and people with great ideas but who are disadvantaged by something such as poverty or lack of access to banking institutions. Microloans serve micro businesses to supply them with the capital they need to purchase inventory, office supplies, or hire employees. But almost any registered business is qualified to apply for a microloan.
Getting approved for a micro business loan can be tough and every lending organization will have its own standards and requirements for approval. In general, you will need to prepare these items:
- A finalized business plan outlining your projected day-today operations. It should describe the type of business you wish to start, how it will operate, what you’ve accomplished in your business so far, and any other information relevant to your business.
- Proof of what you have already invested in your business. Potential lenders will want to see that you are personally dedicated and invested in your own idea before investing themselves.
- If your credit report looks bad or has a few mistakes on it, you will want to take some time to contact the credit bureaus and correct anything misreported. Improving your credit score and cleaning up your report will also improve your chances of getting approved for your loan.
- You may also choose to include a personal story or biography explaining why you are starting this business and what makes you qualified to run the business. Explain your background and any experience you have in the industry or relevant experience to your business idea. Make a selling case for why you deserve the loan.
- It is also recommended to offer some form of collateral or personal guarantee that you will not default on the loan. Most microloan borrowers will not have any form of collateral to offer and could have a bad credit report, so anything you can offer could be a competitive advantage.
SBA Microloans
Some microloans are backed by the SBA, who launched a program in 1992 to help encourage economic development of entrepreneurs in underserved communities. Since most banks have strict qualifying guidelines, entrepreneurs with bad credit or no credit struggle to get approved for traditional small business loans. Or an entrepreneur might need a significantly smaller amount of money than traditional loans permit, so the SBA started endorsing microloans.
Keep in mind that while SBA backs some microloans, they do not service them or issue them to borrowers. They simply distribute funds to designated community-based nonprofits who serve as intermediary lenders. You can find a list of intermediary lenders on the SBA site. The intermediary organization will offer management services and technical assistance for your loan. Lending and credit requirements are at the discretion of the lending organization. SBA-backed microloans are not your only options available, be sure to gather terms from different sources and compare before taking one.
SBA-backed loans have a few requirements:
- Loans can be as low as $500 but no greater than $50,000.
- The loan term max is six years.
- Interest rates will most likely fall between 8 and 13 percent.
Personal Microloans
While most microloans are used by entrepreneurs to start a business, usually a micro enterprise or small business, they can also be used for personal reasons like getting out of debt. Keep in mind that when applying for a personal microloan, you will be expected to disclose the purpose of the loan for potential lenders to consider. You may be less likely to get approved for a personal microloan, because lenders are often more attracted to investing in a business (which is generally designed to turn a profit, increasing the likelihood of repaying the loan) rather than personal loans.
Microloans as an Investment: Micro Lending for Profit?
As an investor in microloans, you might be more familiar with the term, “peer-to-peer lending” or P2P. Peer-to-peer lending is the practice of lending money to individuals or businesses through an online service that matches lenders with borrowers. People who wish to invest their savings, and also help minorities or people in poor, developing countries, may find microlending highly rewarding.
Microloans can command high interest rates because of the higher risk involved. Since borrowers of microloans usually have poor credit and the average borrower has a higher risk of default. This makes microloans attractive, although risky, to investors. Borrowers usually don’t have any collateral to offer, so if they default on their loan, investors lose out on their money.
Because of the high risk for investors, they often choose to invest small amounts per loan and spread their investment across a diverse portfolio of many different microloans in order to decrease the chances of losing their entire investment.
If you’re interested in taking a microloan or using your savings to get involved in P2P lending, check out the SBA-backed intermediary lenders, as well as these top peer-to-peer organizations:
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FAQs
Is microloan a business loan? ›
What is a microloan? The microloan program provides loans up to $50,000 to help small businesses and certain not-for-profit childcare centers start up and expand.
What is an example of a micro loan? ›Microloans can come from a number of different sources — often nonprofits, community organizations, online platforms, and individuals. For example, let's say that the owner of a small bakery is seeking financial assistance to help with some minor repairs that are necessary in the shop's kitchen.
What is the interest rate on a micro loan? ›Interest rates. Varies, typically ranging from 2.25% to 18% Term length. Usually at or under 10 years (term varies by lender; some USDA microloans extend up to 25 years).
What is micro loan scheme? ›Micro Credit Scheme (MCS) refers to a loan scheme that is primarily provided by micro financial institutions (MFIs). These financial schemes are offered chiefly for micro enterprise activities such as agricultural activities, artisan activities, etc.
How do you qualify for microloan? ›- For-profit small business. To qualify for an SBA Microloan, you should have a for-profit small business. ...
- Average credit. Most microlenders don't require excellent credit. ...
- Ability to repay the loan. ...
- Collateral and personal guarantee. ...
- Good character.
SBA Microloan Approval Time
Receiving a microloan can take anywhere between 30 and 90 days. Your application must be approved by both an intermediary lender and the SBA, so patience is key when waiting on a microloan.
Can you make money with micro loans? Micro loans carry high interest rates and can bring potentially very high returns for investors. Our loan originator, Wandoo Finance, makes as much as 200% on the loans they issue — which is why we can offer 14% (and 16%) return to our investors.
What are common reasons for people to apply for micro loans? ›Microlending is the process of connecting a borrower and a lender for a non-traditional, smaller loan. A borrower usually uses microloans if they do not have access to local financial institutions, if they have poor credit, or if they want a loan smaller than what their bank will allow.
Why would an entrepreneur need a microloan? ›At their foundation, microloans are built to help small businesses get up and running. As such, if you're looking to get a small amount of funding quickly to start a business and don't necessarily have good enough credit to obtain a loan from traditional lenders, a microloan could work for you.
Why do people take microcredit loans? ›The benefits of microfinance include: Small loans enable entrepreneurs to start or expand micro, small and medium enterprises. Savings help families build assets to finance school fees, improve homes (e.g., install power or running water) and achieve goals. Insurance products can offset the cost of medical care.
What is micro cash? ›
The open source and free alternative to central banking.
How do I start a microloan business? ›How do I apply for Microloan Program? Small businesses interested in the Microloan Program should contact a Intermediary Microlender in their area. A Microlender is a non profit organization that receives a loan from SBA. In turn, the Microlender makes small loans to very small businesses in the community.
Are microfinance interest rates high? ›These visits often combine education, healthcare and other financial services, adding to the human cost of each microloan. The expenses associated with operating an MFI is one of the reasons that microfinance interest rates often appear high in comparison to other loans.
What is the interest rate on a 10 year business loan? ›Current SBA CDC/504 Interest Rates
Overall, CDC/504 loans carry lower interest rates than the SBA's 7(a) loans. Below are the current estimates (as of October 2022): Effective rate for 10-year loans: About 5.97% Effective rate for 20-year loans: About 5.8%
These loans are generally issued to finance entrepreneurs who run micro-enterprises in developing countries. Examples of micro-enterprises include basket-making, sewing, street vending and raising poultry. The average global interest rate charged on micro-loans is about 35%.
How long after my loan is approved do I receive the money? ›As with banks, it usually takes one to seven days to receive funds after approval. Approval itself is typically offered on the same day you apply, as long as you fit all of the requirements.
How long does it take to get a startup business loan? ›The SBA promises a turnaround time of 36 hours for their express loans. But, that doesn't include the time it takes for the lender to approve the loan, which could tack on another few weeks. So, instead of 60-90 days, you're looking at 30-60 days for the SBA loan processing time when all is said and done.
How long does it take to approve a business loan? ›While some loans offer quick funding the same day you apply or within 24 hours, others take weeks or even months. If you opt for a traditional business loan from a bank, for example, you'll likely have to wait several weeks to get approved and receive the money.
What can an SBA microloan be used for? ›SBA microloans can be used for working capital or to purchase inventory, supplies, furniture, fixtures, machinery or equipment. You can't use an SBA microloan to pay off existing debts or purchase real estate.
What is the importance of microloans? ›Microfinance is important because it provides resources and access to capital to the financially underserved, such as those who are unable to get checking accounts, lines of credit, or loans from traditional banks.
What are the characteristics of micro loans? ›
...
- Durability.
- Solid works.
- Special Expertise.
- Type of product.
- The linkage with other sectors.
- Capital.
At their foundation, microloans are built to help small businesses get up and running. As such, if you're looking to get a small amount of funding quickly to start a business and don't necessarily have good enough credit to obtain a loan from traditional lenders, a microloan could work for you.
How do I start a microloan business? ›...
Here's an overview of how to qualify for a microloan:
- Step 1: Create a business plan. ...
- Step 2: Clean up your credit report. ...
- Step 3: Be prepared to offer collateral or a personal guarantee.
The PPP ended on May 31, 2021. Existing borrowers may be eligible for PPP loan forgiveness. SBA also offers additional COVID-19 relief.
Is it worth it to apply SBA loan? ›SBA loans are generally attractive to small business owners because of their guaranties and interest rate caps. However, drawbacks include long loan closing processes and collateral requirements.
What are the downsides of microloans? ›- Small Loan Amounts. Depending on the maturity level of your business, microloans may be too small for your needs. ...
- Potentially Higher Interest Rates. Microloans don't always have high-interest rates but do when the borrower has a bad credit score.
Can you make money with micro loans? Micro loans carry high interest rates and can bring potentially very high returns for investors. Our loan originator, Wandoo Finance, makes as much as 200% on the loans they issue — which is why we can offer 14% (and 16%) return to our investors.
How much is the loan limit in a microfinance? ›...
314 MICROFINANCE LOANS.
| Subject | Particulars |
|---|---|
| Security | – Like microfinance loans, collateral substitutes may be required |
Accessibility is a major benefit of microfinancing. Investors can support small businesses and new startups in their own country and elsewhere in the world. For business owners, microloans are a way to access funds even with no credit history or a bad credit score.
What are the three main principles in microfinance? ›Principles for Sustainable Microfinance Lending. Recover the costs of the loan. Small loan sizes and personalized service result in costs per loan that require interest rates significantly higher than commercial banks (although significantly lower that informal sector rates). Expect repayment.
Who is involved in micro lending? ›
These loans are generally issued to finance entrepreneurs who run micro-enterprises in developing countries. Examples of micro-enterprises include basket-making, sewing, street vending and raising poultry. The average global interest rate charged on micro-loans is about 35%.
Who are the micro finance players? ›Formal and semi-formal microfinance institutions fall into three categories: banking institutions (formal); NGOs (semi-formal); cooperatives, savings and credit associations (with varying degrees of formality).
How are microloans evaluated? ›Each microlender will have different requirements and loan terms; but, in general, a microlender will evaluate applicants' credit scores, business revenue, other sources of income, business plan and the duration of time you've been in business to assess whether you're a good candidate for their loan program.