Regular Business Loans vs. Microloans: What's the Difference?
By: JeFreda R. Brown, MBA
Figuring out how to finance a business is one of the biggest challenges that business owners face. For most, the choice of obtaining the best business loan is one that takes proper planning. Access to capital is a major topic of discussion these days. Before making major plans, the question to ask is, Should I obtain a commercial business loan or a microloan?
Regular Business Loans vs. Microloans
|Regular Business Loans||Microloans|
|Loan Amount||High maximum limit||Low maximum limit|
|Interest Rates||Lower interest rates||Higher interest rates|
|Loan Requirements||Greater flexibility on what funds can be spent on||Tighter limits on how funds are used|
|Bottom Line||Best for traditional businesses||Best for low income individuals struggling to obtain funding|
A conventional business loan consists of financing obtained from a financial institution such as a bank or credit union. The requirements for obtaining a conventional business loan from a bank are established by each individual bank. For instance, certain documentation is required when applying for a conventional business loan, and creditworthiness is very important. Even though the funds will be used for business purposes, requirements are stricter than ever before; this is largely thanks to the Great Recession. Therefore, a majority of banks require a personal guarantee from the person applying for the business loan.
Banks also work with other agencies--such as the Small Business Administration (SBA)--to provide conventional business loans to businesses. You can find information on all of the types of conventional business loans provided through the SBA. Credit unions have been known to be easier to deal with than banks when it comes to obtaining a business loan. Credit unions also have some different regulations from banks and are able to accommodate a wider range of borrowers.
A microloan is a smaller loan that is normally administered through an organization, usually a nonprofit organization that is community based. The microloan concept was first created by Mohammad Yunus in 1974 at Grameen Bank. Microloans were created to help the poor who could not obtain conventional loans for their businesses. The SBA also has a Microloan Program using intermediary lenders. These intermediary lenders are community-based nonprofit organizations. According to the SBA, their average amount provided for a microloan is $13,000.
One of main differences between microloans and conventional loans is the amount that can be obtained. There is a maximum limit with microloans. Conventional business loans, obtained from lenders such as Lendio and Kabbage, have maximums too, but their maximums are a lot higher than microloans. Microloans normally range from $500 up to $300,000 or even $500,000. Depending on the purpose of the funds, a business may be able to obtain funds in the millions of dollars with conventional business loans.
Another difference is the interest rate. Microloans tend to have higher interest rates than conventional business loans. One reason is because microloans are considered to be short-term loans while conventional business loans, such as those from BlueVine, are largely considered to be long-term loans. Higher interest rates enable the microlender to earn a profit. Since most microloan lenders are nonprofit organizations, they have to be able to raise funds for the organization this way. Another reason for the higher interest rates on microloans is the fact that the guidelines for microloans are not as strict as they are for conventional business loans. Typical microloan interest rates range from 8% to 16% while conventional business loan interest rates may range from 5% to 9%.
Use of Funds
Another difference between the two is the use of funds requirements. Some financial institutions may allow the business to use the funds for any purpose related to the business, including paying off other business-related debts. However, microloan lenders may not allow businesses to pay off debts with the funds. They may require the funds to be used solely for specific business operation needs such as rent, salaries, equipment purchases, and supply purchases.
Some of the major microloan lenders in the United States and globally are Kiva, Grameen America, LiftFund, and Accion. There are even regional microloan lenders such as CDC Small Business Finance Corporation, which serves California, Arizona, and Nevada. PeopleFund serves businesses in Texas. With the exception of Kiva, these organizations work with agencies like the SBA to distribute microloans to businesses. Kiva provides peer-to-peer lending, and it can be done online on their website.
Now that you better understand the differences between microloans and conventional business loans, you can make a more informed decision for your business.