What is an SBA Microloan?
An SBA microloan is a loan of $50,000 or less that is backed by the Small Business Administration (SBA). These loans are not given out by the SBA. The SBA helps small businesses qualify for loans and get better rates by guaranteeing a percentage of the loan. This guarantee serves a similar function as collateral; if the borrower is unable to make repayments, then the SBA will step in and pay the lender a percentage of the outstanding loan back to them. Since the SBA can help mitigate losses for the lender, the loan is seen as being lower risk. When the risk of losing money is lower, the lender can offer lower rates and qualify lenders with lower credit scores.
The SBA only backs loans for small businesses. The SBA has different definitions of what a small business is within the context different industries, but typically they define it as a business with less than 500 employees and less than $7.5 million in annual receipts. While there are no strict requirements for the borrower’s background, the SBA’s microloan program typically focuses lending money to women, minorities, veterans, and people from low-income backgrounds. Part of the intention of the microloan program is to create a more equitable society by helping people from underprivileged backgrounds, who often do not have the credit history or collateral needed to acquire financing, get the necessary capital to start or grow a business. SBA microloans are also ideal for establishing some good business credit history, which can help the borrower qualify for a more substantial loan later.
The size, term, and rates of SBA microloans are determined by the intermediate lender, within the boundaries set by the SBA. The maximum value of microloans is $50,000, but they rarely exceed $35,000, and the average microloan is about $13,000. The term and repayment plan varies between lenders but cannot exceed six years. Microloans can’t be structured as a line of credit.
Rates for SBA microloans are lower than most other microloans because they are backed by the SBA. However, these rates are typically higher than they are for larger loans, because the cost for underwriting the loan is approximately the same, whether the loan is large or small. For a similar reason, smaller microloans tend to have higher interest than larger ones. The lender decides the fees and interest rates, but the SBA requires that the APR (annual percentage rate, the cost of both the interest and the fees) be within a specific range above prime. This generally works out to be between 8-13%.
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Credit Eligibility / Requirements
The SBA does not grant or refuse borrowers for loans. The SBA decides whether the borrower is eligible for backing and then helps the borrower find an approved lender. This lender then decides whether or not grant the loan and the conditions of repayment (within the SBA’s guidelines).
SBA micro loans typically require more paperwork than most non-SBA loans. The SBA will ask for proof that your business meets their definition of a small business. The SBA or the lender may ask for previous addresses, criminal records, educational background and a resume as well. If you are an established business, the lender would likely require you to have proof that your business is making enough money to make the necessary payments. For startups, they like for you to show that you have sufficient training and experience (usually two years minimum) in the same industry as your business.
The most important factor in the lender’s decision to provide you with a microloan will be your credit score. For established businesses, they will look at both the business and personal credit score, as well as the revenue the business has been able to generate. For startups, they use just the personal credit score and supplement it the business plan and other information. Since the SBA’s microlending program is about creating a more equitable society, they may be willing to ignore bad information if there is a sufficient explanation for it.
The SBA will need a business plan that includes how you will spend the loan. Microloans may be used for working capital, supplies, furniture, fixtures, machinery or equipment. The loan can not be used to refinance other debt or purchase real estate. If you are a startup or have a little business credit history, a greater emphasis will be placed on the strength of your business plan.
For Bad Credit
While your credit history is an important part of qualifying for SBA microloan, the microloan program was created to help marginalized people gain access to credit, so the SBA and the nonprofit lenders it works with, tend to be more sympathetic to the contexts from which bad credit arises. If you can offer a sufficient explanation of a previously defaulted loan or missed payment, the lender may be willing to look past it. Smaller microloans usually have lower credit requirements and can be used to help build your credit history to help you qualify for larger loans.
However, if you can’t qualify for any microloans, the SBA recommends getting a business credit card to establish some business credit history.
SBA microloans are a perfect way to get your business off the ground and start building your credit history. Just by taking one out and having it paid off on time, you’ll be better set to qualify for lots of different borrowing options. With decent credit and a solid business plan, you’re all set to start looking for your SBA microloan and get your business moving.