Micro loans are issued by individuals or non-profit organizations instead of banks or traditional financial institutions. The borrowed funds may come from just one lender, or a group of multiple lenders may pool their money to come up with the loan amount.

Microlending typically involves small loan amounts, but the definition of “small” depends on the country. For example, in some countries, micro loans can be as small as $500. In other places, however, any amount below $50,000 can be considered a micro loan.

Microloans can be repaid as a straight loan, wherein interest and principal are paid to the lender upon maturity of the debt. Some microlenders, however, use a weekly or monthly repayment schedule.

Advantages Of Micro Loans

Here are the advantages of availing micro loans:

  • Faster access to startup capital. A startup business that has not yet established a history of income and profitability may find it difficult to qualify for bank loans. In such cases, micro loans can be a good alternative.
  • Microlenders are more nurturing than banks. Instead of just letting you borrow money, microlenders take time to understand what your business is all about. Usually, they also provide suggestions on how you can draft a professional business plan and come up with marketing strategies.
  • Perfect credit rating is not required to qualify. Although most microlenders will still look at your credit history, they typically don’t require it to be perfect. Thus, the requirements to qualify may not be as stringent as with banks.

Disadvantages Of Micro Loans

Though a good borrowing option, micro loans have their own share of disadvantages as well:

  • Access to larger funds can be a challenge. Because investors see microlending as riskier on their part, most of them would only be willing to lend smaller amounts. To gain access to larger funds, you will need to find a microlending company that pools investor’s money together.
  • Defaulting on microloans can hurt your credit rating. Though you are borrowing from individuals or a pool of lenders, skipping your microloan payments can still hurt your credit report.
  • Interest Rates Are Higher Than Banks. Because microloans usually don’t involve collateral and are used for short term funding, they charge higher interest rates than banks. The upside though, is that the interest rates are lower than what you would pay on a credit card.

Who Should Avail of Micro Loans?

Micro loans are ideal for startup business owners and entrepreneurs with limited capital. The money borrowed from microloans is often too small to fund the whole business. However, it can be used for the immediate expenses involved in establishing the business in its early stages.

People who do not have access to traditional financing may also benefit from microloans. For example, borrowers from third-world countries may apply with microlenders who are willing to fund loans from overseas.

What To Consider Before Taking This Kind Of Loan

Have a clear reason why you would like to take a micro loan. The most ideal reason is for business building purposes. However, if you are going to take out this kind of loan for personal expenses, make sure you have the means to pay back the amount. Failure to do so can hurt your credit rating.

Always background check the lender or company issuing the micro loan to ensure they don’t have shady dealings. Carefully reading the offered terms of the loan and fine print will give you a clear idea of the fees involved, interest rates, and other important details.