Should I consider a microloan for my business?

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In a Nutshell

If you’re a small-business owner who doesn’t qualify for a traditional business loan, a microloan could get you started with some of the money you need. Many of these smaller loans are provided by nonprofit lenders and may be available to business owners and entrepreneurs with poor credit or limited time in business. But microloans may have higher interest rates compared with business loans from traditional lenders. Depending on where you live, it may be tough to find a lender in your area.
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Maybe you’ve been denied a small-business loan and your credit is less than great. You’re confident that you could launch your business and turn things around if you can get a loan. But where can you turn?

That’s where microloans can come in. Microloans are small-scale loans that can help small-business owners get the funds they need.

In this article, we’ll look at what a microloan is, how it works, where you can apply for one, and the pros and cons of this loan option.

What is a microloan?

A microloan is a type of loan, typically for smaller amounts, for small-business owners who are starting a new business or building upon an existing one.

The average microloan is about $13,000, according to the Small Business Administration, and can go up to $50,000 or more. Many microloans are secured loans, meaning the lender requires some type of collateral, such as property or an asset, to back them.

Microloans can be used for different expenses, although some lenders may have their own requirements on how you can use the funds. For example, loans offered through the Small Business Administration microloan program can be used for inventory, furniture, working capital or equipment, but can’t be used to pay down existing debt or buy real estate.

Where can you get a microloan?

Microloans are often offered by nonprofit lenders and some peer-to-peer lenders. Here are a few organizations where you can start looking.

Some lenders that offer microloans may limit loans to businesses in certain states or regions. Others may focus on serving specific demographics, such as women or low-income communities. So keep that in mind as you’re shopping around for a microloan lender.

How does a microloan work?

As with other types of loans, you’ll generally make monthly payments toward the principal and interest over a set loan term. The interest rate and terms of a microloan vary by lender (and your creditworthiness), so it’s important to do your research beforehand.

Microloans through the Small Business Administration are capped at $50,000, can be repaid over a term of up to six years and generally offer interest rates between 8% and 13%.

Separately, Grameen America offers smaller microloans, typically between $1,500 and $15,000, with an interest rate that starts at 15%. Opportunity Fund will lend up to $30,000, with an annual percentage rate of 15% to 22.2% and loan terms of up to three years.

If you’re interested in applying for a microloan, be sure you understand the APR, repayment terms, monthly payment, and any requirements or restrictions involved. Some microloan lenders allow you to apply for prequalification before submitting a formal application, similar to the way you might prequalify for a personal loan. This can help you determine if you might be approved for a loan and what the interest rate and loan terms could be.

Benefits of microloans

Microloans can come with several benefits for small-business owners and entrepreneurs.

Potentially higher chance of approval

Microloans are designed for small-business owners who may not qualify for traditional business loans. If you’re struggling to qualify for a traditional business loan, your business might be too new; the amount of money you need may be too small; you may have poor credit health; or you might not have established business credit yet.

Your guide to credit score ranges

In considering your application, microloan lenders can look at factors beyond your credit, including your ability to repay the loan and a solid business plan.

Help in building credit

Microloan lenders might report your loan payments to the business credit bureaus, which could help build your business credit. They may also report to the three main consumer credit bureaus, which could help build your personal credit if you make on-time payments as outlined in your loan contract. In fact, on-time payments are one of the biggest factors in calculating your personal credit scores.

Financial education and resources

Some microloan lenders offer financial support that extends beyond a loan. For example, Grameen America provides financial training, and Accion has a business resource library and helps connect borrowers with other businesses in the community. LiftFund offers business education for both new and established businesses.

Drawbacks of microloans

While a microloan can offer important benefits, there are some other things to consider, too.

Your lender options might be limited

Many microloan lenders are limited to specific regions. Depending on where you live, you may find there are few local options for microloans.

Interest rates can be high

Interest rates for a microloan may be higher than what you could get at a traditional bank. While interest rates for business loans from a bank might start around 6%, interest rates for some microloans can start at around 8%.

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Bottom line

If you don’t qualify for a business loan from a traditional lender, a microloan could provide the cash you need to get your business off the ground or to take it to the next level.

But as with any loan, be sure to do your homework and understand the loan details and restrictions across potential lenders before committing. If you decide a microloan isn’t the right fit for you, you might want to look into how business credit cards work and consider using one to help manage everyday expenses.

About the author: Melanie Lockert is a freelance writer and editor currently living in Portland, Oregon. She is passionate about education, financial literacy and empowering people to take control of their finances. Her work has been f… Read more.