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Updated Nov 08, 2023

How a Microloan Can Help Your New Small Business

If your company needs a short-term, low-interest infusion of funds, a microloan could be exactly what you're looking for.

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Andrew Martins, Business Operations Insider and Senior Writer
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If you’re starting a business and need money to launch or are trying to grow your small business and need money to hire employees or buy new equipment, you’ve likely considered applying for a loan. But if you don’t have an extensive credit history, many mainstream lending options may not be available to you. Fortunately, a lesser-known solution called a microloan can give you a small injection of cash with reasonable interest rates while bolstering your company’s local economy.

Editor’s note: Need a loan for your business? Fill out the below questionnaire to have our vendor partners contact you with free information.

What is a microloan and how does it work?

Many small business loan options are available. Each loan type has its own stipulations, payment periods, interest rates and qualification requirements. Microloans, a type of microfinancing, are no different.

A microloan is a small loan ranging from $500 to $50,000 that must be paid back on a short-term basis. These loans tend to have interest rates between 2.25% and 18%, and are awarded with the intent of helping small businesses get off the ground and continue to grow. Generally provided by nonprofit organizations, these loans make up only a small fraction of business loans in the U.S. In fact, American Express once estimated that only 400 financial institutions offer microloans to entrepreneurs. 

In many instances, the U.S. Small Business Administration (SBA) acts as an intermediary lender, providing nonprofits with the funding for microloans through the SBA microloan program. Though the SBA’s loan program does not “review, underwrite, or have the authority to approve or deny a microloan,” the government agency does set guidelines for the microloan program, such as the previously mentioned $50,000 maximum amount. Other regulations include a maximum loan term of six years, a stipulation that the funds can’t be used to pay off existing debt or purchase real estate, and a requirement for the microborrower to attempt to get a loan from a private source prior to applying for a microloan.

Microloans are useful for short bursts of capital that you’ll use for things like buying inventory, paying employees and swallowing seasonal costs. They’re also a great way to help your business build credit.

Key TakeawayKey takeaway
Microloans are funded by the SBA through intermediary lenders or nonprofits for the purpose of giving fledgling businesses a leg up financially.

Who should consider obtaining 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. Microlenders generally have less restrictive loan requirements, which makes these loans significantly easier to obtain than other options.

Along with helping small businesses get off the ground, many microlenders use their loans to combat existing inequities in the way capital is provided to small businesses in certain parts of the country. While it’s difficult for any up-and-comer to obtain a traditional bank loan for a small business, the odds of being turned down for funding are substantially higher for women and people of color than for their white male counterparts. The prospects are even worse in predominantly nonwhite struggling communities.

To that end, microloan lenders or mission-focused/mission-based lenders tend to provide these loans to minority- or female-owned businesses, businesses serving disadvantaged communities, or low-income entrepreneurs. That’s not to say that companies owned by white men can’t get a microloan, but lenders tend to consider whether the overall scope of a microloan borrower and their business is in line with their own overarching missions. [See the biggest challenges women entrepreneurs face.]

FYIDid you know
Microlenders tend to focus on brand-new businesses and certain groups of entrepreneurs. If your establishment has been in operation for many years, you may not qualify.

How can you qualify for a microloan?

Since microloans are often seen by professionals as a type of starter loan to help a business build credit before moving on to a traditional loan, newer entrepreneurs generally find them significantly easier to obtain than normal loans. While the process for microloans is faster and less stringent, experts suggest there are still some things you can do to prepare for the application process.

The following steps are actions you can take now as a new small business owner to improve your chances of being approved for a microloan. 

1. Establish a business plan.

As a newly minted entrepreneur, you’ve likely already created a general business plan for how you will grow from a startup operation to a profitable company. If you previously applied for a business loan from a traditional bank, then you’ve likely already completed this step as well. The ability to show prospective lenders your strategic plans and prove how seriously you take your enterprise will give some peace of mind to the lending organization. But if you haven’t created a business plan yet, you need to outline how your company will make money, what goods or services the business will deal in, and how you will attract new customers, among other things.

2. Get your credit and financial houses in order.

When you apply for any type of loan, it’s crucial to take a closer look at your monetary situation. The proper calculations of how much you can repay each month give you a baseline for how much you can realistically borrow and how long your repayment period should be. Even though a microlender is generally more relaxed about the money they provide to small businesses, they still need to be paid back. Failure to do so can spell just as much financial trouble as defaulting or deferring on a traditional loan

You should also make sure your business and personal credit scores are in good shape. Even though microloans are typically suited for businesses with little to no credit, lenders often look at an applicant’s personal credit history to see how that person handles their own money. Find errors in your credit report and have them corrected, lower your own credit balances if possible, and clean up some other aspects of your report. When that’s done, you should be an easier approval for most lenders. [Read related article: Factors That Keep You From Getting a Small Business Loan]

3. Prepare collateral or a loan guarantee.

Microloans are provided to small businesses and entrepreneurs with little to no credit history. Without a reliable record to see how trustworthy a borrower is, most lenders will require some assurance in the form of business collateral. Offering some valuable piece of property as collateral can prove to the lender that you’re committed to paying the balance back in full. If you default on the loan, you will lose that collateral and your credit score will take a hit.

What are the benefits and downsides of microloans?

While there are many reasons microloans are a huge benefit to the small businesses they serve, they also have some limitations that can hamper their overall usefulness. Below are some of the pros and cons of microloans.

The benefits of microloans

  • Less-stringent qualification criteria: The entities that offer microloans typically approve borrowers with lower credit scores than other lenders might accept. This alone makes microloans easier to qualify for than other funding sources. Many microloan providers are also less strict about other qualification criteria, such as annual revenue, further lowering these loans’ access barriers.
  • More accessible to marginalized groups: Many microloans come from organizations with a mission of empowering marginalized groups, including both business owners and laypeople. As such, some microloans are only available to marginalized people who own businesses or companies that serve areas with high populations of marginalized people. In either case, microloans may be more accessible to you than traditional loans if you meet these criteria.
  • Easier application with faster funding: Often, microloans disburse the business funding you’ve requested more quickly than other financing sources. The application process for these loans may also be less tedious and strenuous than with other types of funding. This combination ranks microloans among the most efficient funding options available.
  • Less risky: Microloans’ smaller sizes mean that if you struggle to repay the loan amount, you generate fewer expenses. The interest on an unpaid $2,000 loan, for example, is much smaller than on a $300,000 loan. Plus, if you pledge collateral, the lender can recoup their $2,000 without seizing major assets, like property or a vehicle.

The downsides of microloans

  • Relatively high interest rates: Some microloans’ interest rates can be as high as 18%. That’s lower than the interest rates you’ll find with some other loan types, but the SBA’s microloan rates rank among the highest the agency provides.
  • Small loan amounts: If you’re looking for funding that exceeds $50,000, a microloan may not be the right choice for you. Microloans not covered by the SBA can go up to $100,000, but those are generally provided to larger businesses. 
  • Short repayment terms: Similarly, if you need a repayment term longer than six years, you likely won’t be able to find a microloan that suits you. Longer payment terms present higher risks for lenders, who already take on more risk to offer microloans in the first place.
TipTip
Microloans are great for getting modest amounts of funding if you’ve had trouble getting financing elsewhere. That’s especially true if you’re part of, or work closely with, a marginalized community.

Microloan providers

The following organizations provide microloans to small businesses. Check with each lender to find out if any lending requirements have undergone recent adjustments prior to applying. Loan amounts and regulations are always subject to change, so it’s critical to read any loan contract carefully before you sign.

SBA

The most popular provider of microloans is the U.S. Small Business Administration. The SBA provides up to $50,000 in loan funding to help small businesses launch or expand operations. On average, the SBA awards $13,000 in funds per microloan, and most of these loans must be paid back within six years. The U.S. Treasury sets the interest rate for SBA microloans, but they typically average between 8% and 13%. [Find out how SBA loans differ from conventional loans.]

USDA

The USDA microloan program is designed to help farmers who are just starting out or are looking to enter a farming niche. USDA microloans include direct farm operating microloans and direct farm ownership microloans. Each loan program has a maximum limit of $50,000, and applicants can apply to both programs. Repayment terms vary but do not exceed 25 years.

Grameen America

Grameen America is a nonprofit that helps female business owners. To qualify for one of its microloans, the organization asks that you form a small group of five female professionals and attend financial seminars together. At the end of the program, each participant receives a microloan of, at most, $2,000. 

Nonprofits

Nonprofits that serve certain regions of the United States can be an additional source of microloans. For instance, Accompany Capital (formerly known as the Business Center for New Americans) provides microloan financing between $500 and $50,000 to businesses operating in New York City. Additionally, the nonprofit Accion offers a microloan that is among our picks for the best business loans. This microloan starts at $500 and comes with resources and opportunities for networking, education, coaching and training.

Start small, grow big

Microloans are among the most accessible, lowest-risk funding opportunities for small businesses. The limited hurdles for approval and the modest loan amounts mean that with this type of capital assist, you can start small and grow big. For many business owners, that’s exactly the goal. Take the next step by reading our guide to choosing a business loan.

Max Freedman contributed to this article.

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Andrew Martins, Business Operations Insider and Senior Writer
Andrew Martins is an award-winning business and economics expert who has spent years studying trends and profiling small businesses. Based on his on-the-ground reporting and hands-on experience, Martins has developed guides on small business technology and finance-related operations. In recent years, he focused on the small business impacts of the 2020 presidential election and the COVID-19 pandemic. Martins, who has a bachelor's degree in communication, has been published on trusted financial sites like Investopedia, The Balance and LowerMyBills, on technology outlet Lifewire and in the New York Daily News.
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