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Grow Your Business Finances

Microfinance: What It Is and Why It Matters

microfinance
Microfinance institutions give microloans to entrepreneurs who otherwise don't qualify for a standard bank loan. / Credit: isak55 | Shutterstock

As someone who is interested in starting a business, you need resources and capital. So what do you do? If you are like most Americans, you head to your bank and inquire about a loan or seek out investors. While you may successfully get a traditional loan, if you are considered low-income, the odds are stacked against you. That's where microfinancing comes in. Microfinancing has been defined as a provision of financial services that's available to low-income people. This type of loan helps aspiring entrepreneurs generate income, build assets, manage risks and meet their household needs, according to Western Union.

"The end goal of microfinance is to have its users outgrow these smaller loans and become ready for a traditional bank loan," said Yuliya Tarsava, co-founder and COO of CNote.

According to MicroWorld, microfinance has been around for centuries in some form or another, and even longer in Asia as a form of informal lending. What we know as microfinance today was born sometime in the '70s in the country of Bangladesh.

"In the midst of a famine, Dr. Muhammad Yunus, professor of economics at the University of Chittagong, was becoming disillusioned with the abstract theories of economics that failed to explain why so many poor people were starving in Bangladesh," MicroWorld reads. Thus the $27 loan was born as a practical solution.

In the Bangladesh village of Jobra, the professor discovered that a group of 42 females made bamboo stools but did not have the money to purchase the raw materials for the stools. As a result, the women fell into a cycle of debt among the local community's traders. The traders would lend the women the funds they needed with one stipulation: They would sell the stools at a price just barely higher than what the raw materials cost. The $27 came from the entire borrowing needs of the 42 women combined. Yunus lent them his own money, allowed them to sell their stools and got them out of their debt cycle.

Microfinancing evolved with Joseph Blatchford, a former head of the Peace Corps and a UC Berkeley law student. Blatchford founded the nonprofit Accion as a volunteer project in 1961. In 1973, his organization began offering small loans to entrepreneurs in Brazil to see if a one-time influx of money could help lift them out of poverty. The operation was a success: 885 loans helped create or stabilize 1,386 new jobs. Accion expanded the model to 14 other Latin American countries over the next decade.

Editor's note: Looking for information on business loans? Fill in the questionnaire below, and you will be contacted by alternative lenders ready to discuss your loan needs.  

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This specialized form of financing is available through microfinancing institutions in the form of small nonprofit organizations and larger banks. Popular places to go include General Electric Consumer Finance, Citi Inclusive Finance, Kiva, Accion and BRAC. Also be sure to check out our reviews of the best alternative small business loan resources. When you speak to lenders and are granted a small loan, you can also expect assistance setting up and maintaining a savings account. A good lender will equip you with the tools to pay back the loan.

"Although microfinance is often discussed in the international context, there are several lending institutions in America that make these types of loans to increase economic opportunity in local communities," Tarsava said. "Many CDFIs (community development financial institutions) offer microloans to the communities they serve … [with] favorable small-business terms … and they provide consulting resources and financial education to help increase the likelihood of borrower success."

While approval is, of course, up to the lender, there are some things you can do to increase your chances of getting approved.

Lenders want to see that you are taking your business seriously and have a plan; they want to work with people who are likely to succeed. Every successful business plan should have a company overview, introduction, mission statement, market and industry analysis, marketing plan, and operations plan.

Even though you currently don't have a lot of money, good credit makes an excellent impression. Carefully review your report, ensuring that it does not have any false information; if it does, send out disputes accordingly. Did you know you are entitled to one free report each year?

Your personal guarantee is your legal promise to repay the loan. Collateral, such as your house, is something lenders can use against you if you don't repay it. If you're confident your business will succeed, offering these two things makes sense so you can get a loan.

As Fundera notes, a business owner who puts their own personal investment into their company along with a microloan shows that they are serious and will make sure their business succeeds.

For more information, read our guide on how to choose the right small business loan.

Rissa Ann

Rissa has been writing ever since she can remember. After studying writing in college, she earned her first gig with a newspaper and the rest is history. Having had done a stint finance, she found herself heavily interested in personal and business finance and has been writing about the industry ever since.