According to microlender Kiva, more than 1.7 billion people around the world are unbanked and can’t access the financial services they need. This subset of individuals and small businesses falls outside of the parameters of traditional lending, making them perfect candidates for microlending.
For entrepreneurs whose credit or circumstances make the risk of default high, crowdfunded or peer-to-peer financing, such as microlending, offers monetary opportunities that are not available elsewhere. But let’s dig in a bit more.
- What is microlending?
- How does microlending work?
- Microlending Benefits & Risks
- Microlending Organizations
What is microlending?
Microlending involves lending small amounts, usually less than $50,000, to financially challenged individuals or organizations that are unable to obtain conventional loans from banks or credit unions. These modest loans may be provided by a single individual or procured from several investors who each contribute a percentage of the total amount. Typically, they feature lower interest rates or capital requirements than conventional financing.
Widespread Internet access has led to cross-border connections that weren’t possible previously, allowing borrowers and investors around the world to find each other easily. This, in turn, has led to microloan growth.
Microloans, also called peer-to-peer loans, can be used for a range of objectives related to starting a business or expanding an existing one. Examples include working capital, inventory, supplies, furniture, fixtures, machinery, and equipment.
How does microlending work?
Unlike traditional financing methods, profiting from interest and fees isn’t usually what microlenders are looking to gain from their loans. Instead, most of these lenders are driven by a desire to help the disadvantaged in their communities.
Most are non-profits and focus on lending to people or entities that align with their mission, such as women, minorities, and other underserved entrepreneurial groups. Along with financial help, they often provide coaching and training to borrowers to improve the odds of success and repayment.
To get a better idea of how microlending works, here’s a quick example.
Let’s say a small business owner needs $1,000 to repair equipment for her bakery. She doesn’t think she’ll be able to secure financing through a traditional bank and instead opts to use a microlending company.
The microlending platform then matches this business owner with an investor or investors willing to loan the money. Once both the business owner and the investor(s) agree to loan terms, the funds are transferred to the microlending company and then to the business owner.
She now uses the $1,000 she borrowed to make equipment repairs and then repays the loan according to the terms reached in the loan agreement.
Microlending Benefits and Risks
For borrowers, microlending gives access to capital they wouldn’t otherwise have. Microloans don’t require the borrower to post collateral for the loan, making it easier to acquire. According to the US Small Business Association, the average microloan is about $13,000.
Globally the average amount of a microloan is less than $1,000 with 80% of first-time borrowers being women, helping to boost their global economic impact.
Microlending companies and programs are generally focused on uplifting communities through access to capital and encouraging entrepreneurship. In addition to benefiting the borrowers, microlending gives investors the chance to aid communities or causes they care about. Plus, depending on the interest rate, they may earn a little more on their investment.
However, as with most things, there are a few drawbacks. For borrowers, the repayment time frame for microloans can be short, which may put added strain on an already tight budget. For investors, there is a chance the loan may not be repaid. Although the repayment rate for microloans was an impressive 98%, that amount has since dropped below 90% in some countries due to the pandemic.
1. CDC Small Business Finance
The CDC’s Small Business Finance microloans are loans designed to meet the needs of small business owners. These loans are best for new or early-stage businesses. Funds can be used for working capital, operating expenses, tenant improvements, equipment, business acquisition, and refinancing of business debt.
Compared to other non-traditional loans, CDC Small Business Finance microloans provide affordable capital. Each loan comes with 12 hours of complimentary business advising to support long-term success.
These loans are available to businesses that are unable to obtain funding from banks or credit unions. Loans are offered in three-to-five year terms at fixed interest rates between 8% and 10%.
2. Grameen America
Understanding that women are half as likely as men to receive an SBA loan from mainstream financial institutions, granting funds at 3.2% versus 6.4% for men, Grameen America provides microloans (starting at no more than $2,000), financial training, and support to female entrepreneurs living below the poverty line.
Grameen America has a unique business model which begins with the borrower forming a group with four other like-minded women. The group then undergoes training to learn about loans, saving, and credit building.
After the training, each woman in the group opens a savings account and receives a microloan to build their small business. The group meets weekly to make repayments and continue with their business and financial education.
An additional benefit of obtaining financing from Grameen America is that they report microloan repayments to Experian, helping borrowers improve their credit score and qualify for more financing.
Kiva is an international nonprofit, founded in 2005 in San Francisco, with a mission to expand financial access to help underserved communities thrive.
With the motto “make a loan, change a life,” Kiva allows lending as little as $25, and 100% of every dollar invested on Kiva goes to funding loans. Kiva provides interest-free microloans of up to $15,000 that are paid back over a period of up to 36 months.
Kiva microloans have paid for student tuition, helped women start businesses, enabled farmers to invest in equipment, and allowed families to afford much needed emergency care.
Unlike traditional bank loans, Kiva loans don’t require a minimum credit score, years of cash flow documents, or collateral. But borrowers must meet the following minimum criteria in order to be considered:
- The borrower and the business must be based in the United States.
- The borrower must be over 18 years old.
- The borrower must be using the loan for business purposes.
- The borrower business must not be engaged in any of the following activities: multi-level marketing / direct sales; illegal activities (e.g., gambling, scams, etc … ); or pure financial investing (e.g., stocks)
- The borrower cannot currently be in foreclosure, bankruptcy, or under any liens.
- The borrower must be willing to demonstrate their social capital by having a small number of their friends and family make a loan to them.
While Kiva does not guarantee repayment for any loans crowdfunded on the Kiva website, the historical repayment rate is about 97%
4. SBA Microloan Program
The SBA Microloan Program offers smaller-sized loans of up to $50,000 to help small businesses and certain not-for-profit childcare centers start up and expand.
The average microloan is about $13,000, and SBA provides funds to specially designated intermediary lenders, which are nonprofit community-based organizations with experience in lending as well as management and technical assistance.
These intermediaries administer the microloan program for eligible borrowers. Eligibility is determined by each intermediary lender based on their own lending and credit requirements.
Generally, intermediaries require some type of collateral as well as the personal guarantee of the business owner. The maximum repayment term allowed for an SBA Microloan is six years. Interest rates are generally between 8% and 13%.
To find an authorized microlender near you and apply for an SBA Microloan, contact your local SBA District Office.
Other microlending companies include Accion USA, Accompany Capital, Community First Fund, Justine Petersen, LiftFund, and Pacific Community Ventures.
Small Loan, Big Impact
While microlending hasn’t ended global poverty, it has delivered on the promise of transforming someone’s life by supplying capital to start or expand a small business.
Whether microloans are right for you depends on your circumstances and goals for the funds. The key is to know your options so that you can make the best decision for your unique financial situation.
Editor's note: This article was originally published in March 2022 and has been updated for comprehensiveness.