How Do Microloans Work? What You Need to Know

Microloans are a popular form of business financing. Businesses in their early stages of development often use them to cover operational, as well as growth, expenses. Like all loans, microloans are considered debt-based financing. If you obtain a microloan, you’ll have to pay it back to the respective lender. To learn more about microloans and how they work, keep reading.

How Do Microloans Work? What You Need to Know

The Basics of Microloans

A microloan is any business loan with a value of $50,000 less. They are offered by banks and other financial institutions as well as private investors. What distinguishes microloans from other loans is their value. While other loans often exceed hundreds of thousands of dollars — sometimes even over $1 million — microloans have a smaller value. They are characterized by a value of $50,000 or less.

How Microloans Work

The way in which a microloan works varies depending on the type. There are two types of microloans: term and peer-to-peer. Term microloans are the most common type. They work the same as traditional loans, with the borrower repaying the lender. Peer-to-peer microloans work in a similar way except they involve a large group of investors.

Peer-to-peer microloans aren’t initiated by any single investor. They involve a group of investors, all of whom loan a small amount of money to a business. Like with term microloans, borrowers must still repay peer-to-peer microloans. With that said, they often have different requirements and guidelines regarding repayment.

Advantages of Microloans

Microloans are typically easier to secure than traditional bank loans. With their relatively small value, they carry a low risk for banks and investors.

It’s usually faster and easier to obtain a microloan as well. All banks and investors have an approval process. To obtain a loan, you’ll have to apply for it, after which the bank or investor will approve or reject your application. With a microloan, the application process is faster and easier than that of a traditional business loan.

The U.S. Small Business Administration (SBA) has a microloan program. According to the SBA, the average interest rate of its microloans was 7.6% in 2018. That’s about the same interest rate as most traditional business loans. You can obtain SBA microloans from banks.

Microloans aren’t suitable for all businesses. Many businesses need a substantial amount of cash to fund their operations and achieve their goals. For businesses in their early stages, though, a microloan can be an attractive form of financing.

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