Microfinance is a segment of the financial services market that addresses the financial needs of entrepreneurs, small business owners, and under-represented groups such as minority-owned businesses and the unbanked. Depending on the company, they may offer insurance, mortgage, or loans, making up the largest percentage of microfinancing services.
Microloans may be personal or business, but the loan amount is usually less than $50,000, although some lenders may offer as much as $100,000. For small businesses and entrepreneurs, microloans make it possible to borrow money to expand, cover payroll, or purchase equipment when traditional funding is not available.
What Are Business Microloans?
Microloans in the United States are loans for amounts less than $50,000. Outside the U.S., the loan amount depends on local jurisdictions. Microloans are designed to give small enterprises access to working capital that is not available through other financial service providers. These loans can be traditional term or peer-to-peer loans. Traditional micro-loans have a term of fewer than ten years with the interest rate based on credit score and history. Private or institutional investors back peer-to-peer loans, and the process and terms can vary significantly from one micro-lending program to another.
How Does a Microloan Work?
Applying for a microloan works much the same as applying for any loan. Lenders will want to know the loan amount and how the loan will be used. In addition, they will look at your credit score, credit history, and possibly a business plan. Microloans may be available through traditional financial institutions, but online lenders are more likely to offer microloans.
What Can a Microloan Be Used For?
Microloans can be used for any legitimate business expense. For example, they can be used to purchase inventory, pay for product development, or cover operating expenses. Lenders always have the option to place restrictions on how the funds are used. For example, the Small Business Administration (SBA) in the U.S. does not allow funds to be used to refinance existing debt or purchase real estate.
The SBA Microloan Program
Businesses looking for a microloan in the United States can apply for an SBA-funded microloan. The SBA program does not guarantee the loan, but it does provide the funds for intermediary lenders to use. The intermediaries are SBA-approved organizations with experience in lending as well as financial management. SBA loans are capped at $50,000.
Who Qualifies for a Microloan?
A business must meet the following requirements to qualify for a microloan:
- Be a start-up or newly established small business
- Be a growing for-profit small business
- Be a non-profit child care center
- Meet the SBA standards for a small business
- Must be in an eligible industry
- Must be owned by a U.S. citizen, permanent resident, or non-citizen with a work permit
For loans over $20,000, there may be a “credit elsewhere” test to indicate that similar financing was not available from private sources. More information on requirements can be found here.
Each lender uses its lending and credit algorithms to determine if a business qualifies for a loan; however, online lenders often offer lower interest rates and better terms. It is important to note that the SBA does not stipulate a minimum credit score.
What Are the Microloan Restrictions?
Microloans can be used for:
- Working capital
- Inventory or supplies
- Furniture or fixtures
- Machinery or equipment
They cannot be used to pay existing debts or purchase real estate.
What Are the Loan Terms?
Loan repayment terms vary according to the lender, loan amount, and loan length. The maximum repayment period is six years, and the interest rates can range from 6% to 9%. The maximum interest rates are calculated based on federal lending rates.
What is the Application Process?
SBA microloans are available through SBA-approved intermediaries. As of 2021, there are 144 intermediaries. To find a lender near you, contact your local SBA District Office.
How to Qualify for a Microloan
Qualifying for a microloan requires the same information as applying for a traditional loan. The difference is in how the lender applies the eligibility requirements. The first step is to prepare a business plan that shows the condition of your existing company and outlines what collateral or personal guarantees are being offered to secure the loan. Then, the lender will look at the information before making a determination.
Business Plan
A business plan may sound like a daunting task, but the information required is crucial to having a loan application approved. Here are the key elements of a business plan. A summary or cover letter that includes a synopsis of what your business does, how much funding is required, how the money will be used, and how it will be repaid. After the overview, the plan should include:
- Brief company history and the market landscape to provide context for the underwriters.
- List of management personnel, including board members and investors that provide input into operations.
- Loan amount requested.
- How the loan will be repaid.
- What happens if payments cannot be made.
- Financial statements and sales forecasts.
- What is the owner’s equity in the company?
Credit Report
Credit reports will be pulled to compare against information provided in the business plan; however, many online microlenders do not require a minimum credit score.
Collateral and Personal Guarantees
Small business loans often require an asset as collateral or a personal guarantee to secure the loan. If the loan is not repaid or goes into default, the collateral is used to pay off the loan. Personal guarantees allow lenders to use personal assets to repay a loan.
Alternatives to Microloans
If microloans do not seem like the best option, consider the following alternatives:
- Opening a line of credit
- Requesting a merchant cash advance
- Applying for a business credit card
- Getting equipment financing
- Using accounts receivables financing
Before selecting an alternative, talk to a lender with experience in small business lending. They can help you decide on the best option for your business.
FAQs About Microloans
When small businesses look for funding, they can turn to the microfinance industry for help.
Microlenders are organizations that offer micro-financial services to underserved segments of the population.
Microlending is another term for microcredit which is the lending of small amounts of money at low interest to new or growing small businesses.
Microlending targets new or growing businesses that have difficulty getting financing from traditional lenders. These may include minority-owned businesses or companies in developing countries.
Microloans are available from several sources, such as online microlenders or SBA-approved microlenders.
