What Are Microloans? (And How to Tell if They’re Right for Your Business)
As suggested by their name, microloans are small loans tailored specifically to the needs of small businesses.
Entrepreneurs use microloans for everything from startup to expansion costs — and throughout the country, hundreds of lenders and nonprofit organizations offer microloans to eligible borrowers.
Not sure if microloans are right for your business? Here’s a look at the basics:
What are microloans?
Microloans are small business loans, often ranging from as little as $500 and up to $50,000.
To illustrate, Small Business Administration (SBA) microloans, one of the most popular types of microloans in the country, are on average $13,000 and must be paid back within six years.
These loans are used for everything from startup costs, expansion, equipment, and marketing.
What are SBA microloans?
Through its microloan program, the SBA works with local intermediaries to help bring small loans to business owners in need.
To access funding, business owners must apply through a local organization. Their credit scores are taken into account, but in most cases, getting approved for a microloan is easier than getting approved for a business loan through a bank.
The funds from these loans can be used for working capital, inventory, supplies, and machinery, but in most cases, they cannot be used to buy land or pay off existing debts.
Generally, the interest rate ranges between 8 and 13 percent with some exceptions, making the rate slightly higher than the average for a traditional business loan but substantially lower than most credit card rates.
The loans are structured so that they are fully repaid within six years, helping to ensure the business owner doesn’t get locked in debt.
What is the purpose of a microloan?
The purpose of a microloan is to help small business owners access the funding they need for success, but in most cases, these loans are also designed to help support communities by fostering the success of small businesses in the community.
To that end, some microloan programs are designed exclusively for business owners from historically marginalized groups or in important industries.
For example, the Business Center for New Americans in New York City has given out millions of dollars in microloans to immigrants and refugees, while Grameen America grants microloans to female entrepreneurs and Accion works primarily with low to moderate-income entrepreneurs.
In other cases, microlenders reach out to businesses in industries that are beneficial to the community, such as child care centers, non-profit organizations, or green businesses.
Who uses microloans?
Although some microloan programs are tailored to specific groups of people or types of industries, anyone can apply for a microloan, and annually, between 250,000 and 300,000 entrepreneurs apply for these loans.
These entrepreneurs represent businesses ranging from startups to well-established endeavors, from nail salons to veterinary clinics, from restaurants to professional cleaning companies and from home-based businesses to brick-and-mortar establishments.
However, in most cases, these loans are favored by people who have been turned down by banks, who don’t have collateral to secure traditional financing, who have less than perfect credit scores or who don’t want to be mired in credit card debt.
In other cases, entrepreneurs turn to microlenders because they only need a small amount of money, and a microloan makes more sense than a traditional business loan.
How do microloans foster business development?
Microloans are about more than just money. They help foster community development, and that spirit often defines the set-up of these loans.
In particular, many microloans come with development opportunities. To that end, recipients of these loans may be paired with a mentor or required to take certain business development classes.
What are the benefits of microloans?
Aside from their involvement with business and community development, microloans offer a host of other advantages as well.
The small loan amount helps to ensure that business owners don’t get over their heads in debt, and in most cases, these loans are structured as installment loans, providing the borrower with convenient, predictable monthly payments that they can easily budget around.
Most importantly, microlenders often work with borrowers who have less than perfect credit scores, and there are even credit builder loans for entrepreneurs who are still working on establishing good credit.
What are the disadvantages of microloans?
In spite of the vast number of benefits of these loans, there are some drawbacks.
Namely, the interest rates tend to be higher than traditional bank loans, with analysts quoting rates as high as 18 percent in some cases.
Additionally, the relatively small amount of these loans simply isn’t enough to cover the working capital needs of some business owners. Owners might look into applying for a traditional loan or a line of credit should they need more than what microloans can offer.
Find the right funding option for your small business
Microloans are small loans, designed to support individual businesses, while also helping communities and fostering entrepreneurial growth.
These loans are not the perfect solution for every small business, but they are critical in some situations — and in many cases, they provide small business owners with the capital and support they need to succeed.
If microloans don’t fit for your business, don’t worry. There are plenty of other options out there.
At Kabbage, we provide alternative funding for small businesses, from small business loans to lines of credit to inventory loans. Learn more about the many types of Kabbage’s small business loans here.
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