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What Is Microlending and How Does It Work?
Microloan lenders are organizations that lend out small amounts of money, typically in the range of $5,000 to $50,000, to entrepreneurs who can’t secure working capital from more traditional financial institutions or credit cards.
Many microloan lenders are non-profits that rely on donations from charities for their loan funds. Some focus on microlending to specific categories or types of borrowers, such as women-owned or minority-owned small businesses or ethnic markets, such as Hispanic business owners. The Small Business Administration also provides funds to intermediary lenders that have expertise in microlending.
What Are the Benefits of Microlending?
Microloan lenders often provide community based benefits to small businesses in addition to multiple financing options, such as:
- Education and training to clients
- Help for new entrepreneurs
- Encouragement for borrowers in developing countries without access to credit cards or who have poor credit scores
- Support to minority small business owners
What Are the Risks of Microlending?
Microlending does carry some risk for both borrowers and investors. Intermediary lenders typically prefer to invest a small amount across a large portfolio of microloans to spread their risk more broadly.
For borrowers:
- Generally, microloans carry higher interest rates than a traditional bank loan because they’re not always backed by a personal guarantee. Interest rates can range from 8% to 13%.
- Often, microloan amounts are subsidized by federal, state and local grants. A borrower’s credit score and credit history will determine not only the interest rates of microloans, but also the repayment terms. The maximum repayment length for a Small Business Administration microloan is six years.
For investors:
- Intermediary lenders may want to require a personal guarantee or some type of collateral from the small business owner to protect themselves if the borrower defaults on the loan.
- Microloan lenders should only invest in trustworthy borrowers who can provide a detailed business plan and even a personal story.
Who Uses Microlending?
Microloans can help small businesses get established, grow and flourish. Entrepreneurs with little or low credit history can seek small amounts of funding from peer to peer investors instead of struggling to attain traditional bank loans. Microloan programs may be right for a variety of small businesses, such as:
- Construction companies
- Personal services like salons and spas
- Private medical or legal offices
- Restaurants
- Specialty shops and more
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