What started as a way to give people in impoverished countries the means to improve their quality of life has become an attractive lending option for small business owners seeking quick cash.
Microloans, which are defined by the Small Business Administration as $50,000 or less, can be a source of capital for those finding it difficult to acquire needed funds from credit markets that are still extremely tight, says President and CEO of the ACCION Network in the U.S. Gina Harman.
Because of their less rigid requirements, microloans have a broader spectrum of possible applicants who are either lacking credit or deemed too risky of an investment by traditional financial institutions, says Caitlin McShane, Marketing and Communications Director for Opportunity Fund.
“Microlenders have been described as the lender of last resort, but we don’t see ourselves that way,” Harman says. “We’re a credible lender that understands local small businesses.”
Is a Microloan Right for You?
Mircolending takes banks out of the equation with funds disbursed through intermediaries. Harman estimates there are about 275 microlenders in the U.S. with only about half funded by the SBA.
Although “micro” refers to the size of the loan, small business owners can receive more than $50,000, depending on the intermediary. Opportunity Fund, for example, gives loans up to $100,000.
“I guess that brings up the point of why would we go up to $100,000 if you can get that from a bank?” says McShane. “Even if you can qualify at a bank, they’re probably going to charge you a lot because of your risk.”
Interest rates vary with each microlender but are typically 8-13%, with loan terms capped at around 6 years.
Microloans may be used for several purposes including working capital or purchasing equipment and furniture. However, Dennis E. Byrne, Office of Communication and Public Liaison for the SBA, notes that using the loan to pay existing debt or to purchase real estate is expressly forbidden.
Choosing a Microlender
When it comes to selecting a microlender, Byrne explains that SBA-backed, non-profit intermediaries are closely screened for their capacity to deliver the Microloan Program effectively.
“This includes, among other things, a review of an organization's loan policies and procedures; and a review of the personal histories of key personnel and board members,” he says. “This helps mitigate risk of predatory lending to both the agency and the potential borrower.”
So is it a safer bet to go with an SBA-backed microlender? Not necessarily, says Harman.
“In the last couple of years, the SBA has been diversifying the kinds of organizations they work with,” Harman says in reference to the SBA intermediaries that cater to specific small business owners and business types. “But I think when a potential borrower is trying to evaluate where to go, the things that are important are the kind of relationships that will get somebody through the application process.”
Preparing for the Application Process
Applying for a microloan can offer a small business owner more personalized lending options, which is ideal for those with little to no business experience.
“Microfinance is powered by the people and it’s about the time we spend getting to know the borrower and looking beyond FICO scores,” says McShane. “Come ready to talk, and don’t be scared of what you have in your history—let’s just understand it.”
McShane also encourages those considering a microloan to take advantage of the business training offered by microlenders. Byrne mentions that much of the training depends on the intermediary but generally includes “one-on-one counseling tailored to the specific need of the microborrower.”
Harman notes that the best kind of borrower has a realistic viewpoint of his or her business, weaknesses included.
“Instead on engendering a high level of trust, small business owners who are less direct about their financial status would likely engender a certain amount of caution on the part of the loan consultant," Harman says. “It’s about being up front, honest, and proactive.”