Microloans: What They Are & How To Take Advantage

Microloans: What They Are & How To Take Advantage
Eric Goldschein
on March 16, 2020
Read in 11 min

Microloans refer to a category of financing where you can qualify for short-term working capital (or even start-up capital) with low-interest rates as long as you meet some special qualifying criteria.

If you’re an entrepreneur looking for an infusion of capital to jumpstart your small business idea, to make emergency repairs to your existing business, or to take operations to the next level with new equipment, you’ve come to the right place.

After all, you wouldn’t want to overextend yourself with a traditional term loan if you qualify for a low-interest small business loan, would you?

Consider this an invitation from us to dive right into the wonderful world of microloans in 2020!

We’ll start with the basics.

Funding Options APR Do you qualify? Time in Business Annual Revenue
Funding Option
Lendio Get Started
Starting at 5%
Estimated Apr
Do you qualify?
Time in Business
At least 6 months
Annual Revenue
At least $100K
Funding Option
Kabbage. Learn More
1.5% - 10%
Monthly Fee Rate
Do you qualify?
Time in Business
At least 1 year
Annual Revenue
At least $50,000

What are Microloans?

Microloans are exactly what they sound like:

Small loans, which are on average about $13,000, according to the U.S. Small Business Administration.

With that being said, microloans aren’t always so small.

They’ve been known to range anywhere from about $500 to $50,000—

So below the amount of what a large bank might extend you, but above what you might get from asking your friends to pitch in.

Learn more about Why Big Banks Don’t Lend to Small Businesses

Often, microloans are extended by lenders on a short-term basis.

Unlike bank loans, which are made as a for-profit venture by financial institutions, microloans are sometimes underwritten by non-profit organizations.

Non-profit microloans are reserved for self-employed entrepreneurs, new startups, and very small businesses that align with the non-profit mission in order to give recipients the greatest possible chance of success.

Microlending has its roots in Bangladesh, where Mohammed Yunus started the Grameen Bank to extend small loans to local businesses that would otherwise never have the means to get started.

While the vast majority of the millions of microcredit deals still take place outside the U.S., the American small business scene is now beginning to see the value of microloans.

See Business Lenders

Microloans: Why Should You Care?

When we think of securing financing, we think of banks, even today.

We’ve seen enough movies, or remember the days when our parents needed a loan for their business, and our first thought is to go there.

But if you’re a small business owner, you might already know how tough it is to get a small business loan from a bank: 4 out of 5 small business loan requests are rejected.

This can happen for a number of reasons:

Your business isn’t established.

We’re not saying your business idea is no good, or that you’re a bad person.

But the banks will want the safest bets possible when extending loans, and if you don’t have a long history of turning profits, banks will be reluctant to take a risk on you.

Microloans are different because microlenders have a different set of motives.

You aren’t asking for a million dollars.

As mentioned above, banks like to underwrite large loan amounts—

$250,000, or $500,000, or even millions of dollars in loans so that their returns on investment are larger.

That’s just “business.”

But if your business only needs $20,000 to take advantage of a great deal on inventory, or to expand your current location—

You’ll probably find yourself being shown out the door of your local bank.

Microloans, by definition, are more suited to small business needs.

You don’t have the best credit.

To get a loan from a traditional bank, you’ll need an established history of good credit.

If you’re new to the credit game, or if you’ve had some trouble (either with a personal credit or business credit, which can affect each other) in the past, that’s a huge strike against you.

Microloans are based on other qualifying criteria, and your credit score may not matter as much with these types of lenders.

So even if you’re just starting up, you only need a relatively small amount of money, and you don’t have an elite credit score, microloans may offer a glimmer of hope.

See Business Lenders

Who Qualifies for Microloans?

Though exact standards by lending institution and intermediary will vary, any registered business may qualify for microloans.

No business is guaranteed a loan of any kind, of course, so if your credit is particularly bad, you may still have some trouble.

However, specific microloans may be available to:

Further, being environmentally-conscious companies or entering a certain industry may open you up to microloans.

How To Request a Microloan

There is a four-step process, give or take some additional details depending on what kind of business you own, involved in preparing to submit a micro loan request.

Before any microloans come your way, you’ll need to prepare a finalized business plan, full knowledge of your personal and business credit scores, collateral and/or a personal guarantee, and have some funds of your own ready to invest.

1. Finalize your business plan

There is no business without a business plan (whether you’re requesting a loan or not.)

A business plan outlines the goals of your business, how your business will turn a profit, how you’ll establish and expand your customer base, your vision of the business’ future, and other salient business details.

Writing this out in a formal document is crucial, both for your own benefit as the business owner and for the lending institution.

Why does a lender need to see your formal business plan?

Imagine someone approached you for a business loan.

Surely you’d ask why they wanted it, and if they’d replied: “Oh, I don’t know, some kind of business, maybe we’ll sell hot dogs, or maybe it’ll be a combination laundromat-hair salon, I haven’t thought much about it…”

Well, you might not feel so great about handing the money over.

Remember: Microloans are not free money.

While the lenders are extending a helping hand, they do expect you to return the money given to you, plus interest (albeit at a low rate).

A business plan establishes the strength of your business model as well as the seriousness of your intentions.

2. Understand your credit scores

As mentioned above, microloans don’t require elite credit scores.

Still, you should know what your personal and business credit scores are, and do your best to clean them up before requesting any kind of loan.

It’s good financial upkeep, and the better your credit score, the better your interest rate and terms will be.

To check your personal credit, visit the three major credit reporting bureaus (TransUnion, Experian, and Equifax) and pull your yearly free credit report from each to make sure everything is accurate.

Your credit score might be lower than you expected, and that could be due to mistakes (accounts that have been linked to your name without your consent) or oversight on your part (delinquent payments on a credit card you opened up in college and forgot about), both of which you can rectify in short order.

You can also pull your business credit report, through Dun & Bradstreet.

If you’ve never opened a business before, the report might be blank.

This report may also contain errors, and if so, you’ll need to reach out to the credit bureau to fix it.

Armed with the knowledge of your credit standing, you’re ready to take the next step.

3. Assemble your collateral and/or a personal guarantee

In general, microloan lenders require that the business owner puts up some type of collateral, and/or a personal guarantee, in lieu of solid credit history.

In this case, collateral will likely be valuable personal property, such as a home or vehicle, in case you default.

But not everyone who starts a business has, say, a home equal to the value of the loan they’re taking out.

In that case, you’ll sign a personal guarantee allowing your lender to seize any current or future savings, investments, or other assets which can be used to repay the loan.

Of course, this is a worst-case scenario.

The goal will be to take the loan, use it to start or improve a business, and then repay the terms of the loan with no problem.

Luckily, microloans are usually small enough that even a worst-case scenario shouldn’t be devastating to your personal savings.

4. Prepare your own funds for investment

What, you thought the loan was going to do everything?

Lenders will want you to show effort and monetary commitment of your own in addition to receiving their loan.

Part of what you’ll be eligible to receive from the Small Business Administration, for example, is based on your specific need.

Therefore, personal savings and income level will affect your ability to qualify.

Learn more about SBA Microloans

Be prepared to share paperwork such as your recent income tax returns and company balance sheets.

Some intermediary lenders will look to see how much of your income has been invested in the business’ success.

Once you’ve completed these steps, you’ll be on your way to potentially requesting a loan.

But where do you even begin?

Where To Find Small Business Microloans

The primary means of acquiring microloans is through intermediaries that receive their funds from the SBA.

The SBA has been around since 1953, though it was in 1992 that the department began a specific effort to elevate and support entrepreneurs in underserved communities that eventually became the SBA Microloan Program.

The SBA received a $54 million grant from the Obama administration in 2009 to combat the credit crisis, which has helped expand access to microloans considerably.

While the SBA is the keeper and provider of their funds, those requesting microloans must actually request them via intermediary non-profit organizations that the department selects to disperse the money.

What Are SBA Microloan Intermediaries?

Microloan intermediaries are either private nonprofits, quasi-public or tribally-owned entities that have at least a year of experience providing microloans, as well as experience providing in-house marketing, management, and technical assistance.

These organizations won’t just hand you some money and wish you luck:

They’ll become an integral part of your company’s growth and success.

The SBA selects these organizations based on a number of factors, including the availability of funding and the need for program participants in certain geographical areas.

They undergo a rigorous request process as well—

Your buddy Mike from down the block won’t make it as an intermediary just because he says he’s good with money.

The SBA lists its Top 25 Microlenders on its website, and includes the number of loan approvals each had and for how much (in FY 2015).

Some of the biggest intermediaries for microloans include:

You can try your luck with each of these organizations, or simply fill out a form on LendGenius.com to see if you connect with a lender.

SBA Microloans

Not all microloans are created equal.

As we’ve seen, the financial specifics of each loan varies depending on which intermediary provider you go with.

There are, however, guidelines that all SBA-funded microloans must meet.

If you’re ready to look at microloans, expect the following:

Low Borrowing Amounts

…Hence the ‘micro’ in microloans.

SBA-backed micro loans are capped at $50,000.

There is no “one-size-fits-all” loan situation here:

What you need can and should be carefully negotiatied with your microlender.

Learn more about Deciding How Much to Borrow

Short Terms

Traditional bank loans sometimes have term lengths measured in decades.

But microloans can’t have a term longer than six years.

Many, of course, will be even shorter.

It depends wholly on what your microlender extends you.

Varied Interest Rates

SBA loans and microloans have interest rates between 8 and 13 percent, though this depends on your credit, business venture, and the costs of the U.S. Treasury.

Learn more about the 2018 Fed Rate Increase

Microloans – Use of Proceeds

The official SBA website lists four main purposes microloans can be used for:

Microloans can be used for working capital.

The money needed to run day-to-day operations, such as paying employees or basic expenses like rent and utilities.

Microloans can be used for purchasing inventory/supplies.

If you’ve got everything in place but your inventory, SBA microloans can help. This is also useful if there’s an unexpected sale on a crucial material that would make future orders cheaper.

Microloans can be used for buying furniture/fixtures.

If you need chairs for your waiting room, lighting fixtures for your main space, art for your walls, desks for your office—that’s all covered. Just don’t overextend yourself by making frivolous purchases like original Picassos and the like.

Microloans for financing machinery/equipment.

Fixed assets such as kitchen equipment, vehicles, computers, and anything else involved in the production of income are also fair game here.

A nice perk here is that the equipment you want to buy can be used as the collateral for the microloan itself.

However, SBA microloans do have some limitations:

Microloans from the SBA (or any lenders, for that matter) aren’t free money, and they might come with strings attached.

There are two important no-nos when it comes to using your SBA loan:

Microloans can’t be used to purchase real-estate.

You can’t buy land, even if it’s with the goal of eventually building and expanding your business to that land.

Microloans can’t be used to pay existing debts.

Getting into debt just to pay off a debt  (even if the terms are friendlier) isn’t the solution.

Otherwise, you’re good to go.

Learn more about Debt Financing vs. Equity Financing

Okay, So How Do I Request a Microloan?

If you think a loan through an SBA intermediary is the right choice for you, there are three simple steps to follow.

Step 1: Choose your intermediary.

Simple enough!

Go down the list of the best intermediaries on the SBA website, or search for another one online.

Though you could technically request almost any intermediary across the country, you might be best served choosing one in your region or community, or selecting one that is geared towards providing funds for your business or for your background (i.e., women-owned or veteran-owned businesses).

Step 2: Complete business development requirements.

Because using an SBA-backed loan is as much about learning about financial responsibility and money management as it is receiving funds, some intermediaries may ask you to take business training classes or demonstrate your knowledge in other ways.

Don’t blow this off: Your microloan’s dispersal may depend on it.

Step 3: Submit your request and wait for a decision.

The intermediary loan officer can help walk you through the process.

Once you submit your request, be prepared to wait a while.

Both the organization you submitted to and the SBA itself must approve your loan before you receive funds.

Wait times of a month or more are not uncommon.

Microlending Options Outside the SBA

The SBA may be the primary source of microloans, but it isn’t the only option, and it may not be the best option for you at this time.

While the SBA’s funds are federal, other microlenders receive funds from state and local governments, as well as from philanthropists, and more modern options such as peer-to-peer lending networks or crowdfunding.

Well-known microlenders that aren’t affiliated with the SBA include

  • PayPal
  • Kiva U.S.
  • Accion USA
  • Trustleaf
  • Business Center For New Americans
  • & many more.

You’ll want to do your research as to which lender can provide the best micro loan, on the best possible terms, while still making themselves available for assistance (as the SBA intermediaries do) when need be.

Microloans – Dangers & Disadvanatages

The consequences of misusing, wasting, or otherwise mishandling your microloan are very real (regardless of which organization lends it to you.)

The drawbacks of any types of business loans should always be considered.

For example, while SBA-backed loans typically have low interest rates, the annual interest rates of some micro lenders can be higher, as much as 18 percent

Which is even higher than the rates offered by banks!

You’re also prohibited from using microloans to pay off personal debt or make personal purchases.

Basically, don’t say you want a small loan ostensibly for your business, then use it for your personal gain.

In general, mixing your business and personal finances is a risky choice.

Keep them separate and your losses will hopefully be minimized.  

The Bottom Line: Microloans Are an Option for Fast Funding

Traditional bank loans are best for borrowing large sums of money, but may require more time and patience while you wait for a decision.

Microloans are often extended more quickly, for dollar amounts that are smaller.

In any case, you shouldn’t request a loan unless you need it.

Going into debt should never be the first option.

If however, you see it as necessary for your business’ future success and you believe lenders will see it the same way—

Then consider a microloan, especially if you’re new to business and just getting started.

SBA loans may be a good choice, but some other nonprofit lenders may also have your best interests at heart.

If you have more questions, look around at other loan options before deciding.

This is the future of your business we’re talking about, so take your time and feel free to refer back to this guide anytime you’d like before making a decision.

That’s what we’re here for–

Good luck!

See Business Lenders
Eric Goldschein Finance Journalist

Eric Goldschein is a freelance journalist who covers entrepreneurship, small business trends, emerging technologies, culture and sports.

He was previously the managing editor of SportsGrid.com, and has written for Business Insider, Trep Life, the Huffington Post, Fundera and more.