Since then, the microlending definition has transformed. Today, small business owners and entrepreneurs in developed countries also use microloans to finance their ventures. In the United States, the Small Business Administration (SBA) defines a microloan as any loan with less than $50,000. Unlike Grameen Bank, SBA lender’s microloans come in at an average amount of $14,434. While $14,000 may seem small to established businesses, it can be game-changing for new entrepreneurs. Given the potential benefits microlending might provide for your business, it’s worth a closer look. In this post, we’ll review how microlending works and the pros and cons of this funding option.
What is Microlending, and How Does it Work?In terms of structure, microlending works similarly to a typical term loan. The lender evaluates the borrower’s application, provides approval status, and offers a loan with specific terms and conditions. Assuming the loan is accepted, the borrower pays it back with interest based on an agreed-upon payment schedule. Just like a traditional business loan, microloans may carry fees and penalties. Microlending is distinct from traditional lending in that it involves smaller loan amounts. Also, the lenders and borrowers participating in microlending are often individuals, nonprofits, and alternative lenders. Unlike traditional lending, microlending isn’t dominated by banks and credit unions. Many microloans are made through peer-to-peer (P2P) lending platforms. On these platforms, many individuals come together to invest small amounts of capital into many different loans. If you get a microloan from a P2P platform, the money from that loan likely comes from several individual investors.
What Are the Pros and Cons of Microlending?
The Pros of Microlending
1. More Lenient Qualification CriteriaQualification criteria vary by lender, but it’s generally less stringent for microloans than traditional loans. You should still expect to be asked for personal and business financial information. Also, most lenders, including SBA lenders, will require a personal guarantee and collateral. Fortunately, with a low average loan amount, the collateral you need for microlending doesn’t need to be extremely valuable. For example, if your collateral must be worth 80 percent of your loan amount of $10,000, it only must be worth $8000.
2. Wide Variety of Available UsesMicroloans are like general commercial loans in terms of how you can use the loan. For example, with the SBA’s Microloan program, borrowers can use loan funds for expenses such as:
- Working capital
3. Diverse Lender OptionsWhile not all lenders offer microloans, you can find microloans from many different types of financial institutions, such as:
- Alternative lenders
- Traditional banks and credit unions
- Government agencies
- Peer-to-peer lending platforms