What is Microlending?

There are many financing solutions available to small business owners but the most accessible one is microlending. Microlending has been gaining popularity in the recent years.

Microlending is the price of giving small loans to those business owners in need. These can range from $25 to a few hundred dollars. Microlending refers to any help given to people who would not otherwise benefit from traditional financial institutions. Microloans started out to help business owners and entrepreneurs who have no access to funding or cannot get funding from banks because of their lower credit scores.

Some common uses for microloans include:

  • Buying inventory or supplies
  • Covering payroll or employee training costs
  • Paying for seasonal expenses
  • Investing a new marketing strategy or campaign

How Does Microlending Work?

Microloans work like most other term loans; borrowers get a certain amount of cash that they have to pay back with interest over a period of time. Interest rates on microloans tend to be high. That is because it is riskier to lend to entrepreneurs with poor credit and borrowers do not put-up collateral.

Microloans can come up with stipulations for the borrower such as the microlender might require the borrower to take an educational workshop or business class before they can receive their funding.

The majority of traditional financial institutions do not see the payoff in microlending, most microlending occurs on peer-to-peer platforms. The Small Business Administration has a microloan program designed to help women, low-income, veteran, and minority entrepreneurs get access to working capital, suppliers, or equipment. On average, the SBA microloan has a 6% interest rate and is around $14,000.

Benefits of Microlending

Microlending can help entrepreneurs from marginalized communities or get their business off the ground. It can also help create job opportunities, reduce poverty, and further education in the long-term.

As a microloan lender, there is a small financial incentive in the form of interest, but there’s also a chance that a borrower could default on the loan. It is important to note that micro lenders do not dabble in microfinance for ROI.

What to Know as a Borrower

If you need money for your business and struggle getting help from traditional financing institutions, microlending might be your best option. Its appeal is how easy and accessible it is. If you have a promising business plan and a compelling story, getting a microloan might be easier than using a bank.

There are risks to taking a microloan and funding is not always fast. You could wait weeks or months before getting the funds you need. Additionally, if your business does not succeed, you might be stuck paying high interest rates which could leave you in major debt.

Consider the following factors before making a decision:

  • Your location and access to funding
  • Your credit score
  • How much money you need
  • Your business’ profit potential

The Bottom Line

Microlending is made possible by the peer-to-peer economy. Lenders might fund a single microloan while others might spread investment across several microloans. They carry high-interest rates because they are typically much riskier than other forms of borrowing and do not post collateral in case of default.