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What Is a Micro Loan?

Lucy Miller 6th Jul 2020 One Comment

Reading Time: 5 minutes

Have you got a small business idea that you’re struggling to get off the ground? Got a clear vision, but struggling with the upfront costs? If that sounds like you, you might want to consider a micro loan. 

A micro loan can release the capital that could help you take the first steps in your business venture. Here, we’ll explain what that means, who is eligible, how you can go about finding a micro loan, and what you should know if you do decide to take one out. 

Micro loans: a quick definition

Micro loans are often peer-to-peer

A micro loan (also known as microcredit) is a loan that enables a small business to get off the ground. Designed to support entrepreneurship, micro loans typically work in an ethical way, but still include interest payments and need to be paid off as any traditional loan would. They are available to those who might not be accepted for standard bank loans, or who might not have collateral that could be put up against more traditional offerings. 

It’s important to know that micro loans are not the same as payday loans. We’ll talk more about this later. 

Peer-to-peer lending

A type of micro loan that still falls under the banner of “microfinance” is peer-to-peer lending. Peer-to-peer lending allows individuals to lend to others via platforms set up for the purpose. It helps those not eligible for traditional bank loans (such as brand-new companies or those needing small loans) to fund their business venture.

Peer-to-peer lending has been around for less than two decades, but lots of companies now exist that facilitate the lending of money between individuals. Although they all offer a similar service, there are differences in loan amounts, duration of the loans, and so on. Research fees, costs, and terms before agreeing to taking any loan.

If you’re considering being the party that lends rather than the party that takes out the loan, there are things that you should definitely be aware of. With peer-to-peer lending, you are not protected by the Financial Services Compensation Scheme (FSCS)]. This means that if your platform collapses, you wouldn’t be protected or entitled to compensation. This is very different to a traditional loan set up, which comes with many more guarantees. 

Getting guarantors

A guarantor is a person who can provide a guarantee that the loan will be able to be paid back if you yourself are unable to do so. You don’t always need a guarantor to take out a loan, so it’s important to check whether or not you need one with whoever is offering you your micro loan. 

If a guarantor is a requirement, you’ll need to work out who fits the bill. Almost anyone can be a guarantor, as long as they fit certain requirements. These requirements might differ slightly, but in all cases where a guarantor is required they will need to:

  • Know you well 
  • Be in a financial position to take on the debt if you find yourself unable to 
  • Be over the age of 21 
  • Have a good financial history 
  • Be aware of the financial risks involved 

A financially stable relative is often the best person to approach in the case that you do need a guarantor. However, bear in mind that retired people aren’t as favourable to some lenders as a guarantor. This is because they only have pension incomes rather than employment, so may not be in a position to pay your debt without depriving themselves of assets (like their home).

How to raise a micro loan

How to get a micro loan

Although a huge number of micro loan organisations operate internationally, there are companies offering micro loans to small businesses and individuals in the UK. 

At the moment, the UK Government is also offering a micro loan scheme for small businesses. These loans, known as the Bounce Back Loan Scheme, are of between £2000 and £50,000 and are designed for businesses that have been struggling during the coronavirus crisis. 

Crowdfunding is another way that micro loans have gained traction. In this case, individuals can choose to “crowdfund” or invest in certain projects that they deem worthy. Of course, this is not a straight-up donation like you might see for charity. It’s a boost for an entrepreneur, meaning those who invest should see a return when the business in question takes off. If you’ve got a solid idea that you think could make waves, setting up a crowdfunder could be a great idea. 

Pros of micro loans

Micro loans can be a great way to kickstart your business, especially if your financial position means you’re unable to take out more traditional financial lending. They are designed to help out the most vulnerable in society, giving a boost to those from marginalised groups that might need it the most.

These are just two reasons why micro loans are helpful in the developing world. Women tend to benefit hugely from micro loans, because they are typically an under-represented demographic in traditional bank lending. The repayment terms may also be kinder than other types of loan, making them a good option for those whose financial situation might be precarious.  

Cons of micro loans

Questions have been raised about the value of micro loans in recent years. This has often centred on the fact that the recipients need to have the skills, knowledge and time to make a success of their business.

Criticism has centred around a potential lack of education. This could see the recipients of micro loans fail because they don’t have the support to push through on their ideas. If you’re considering taking out a micro loan, you need to have a clear plan for how you’re going to make your idea a success. Some micro loans, such as the Startup Loans backed by the Government, offer business mentorship as part of the package.

How micro loans differ from payday loans

Micro loans differ from payday loans in a number of ways. One is not a substitute for the other! Here are the key differences: 

  • Payday loans are for people who want to fix a problem quickly (although it’s unlikely that they will actually do this). Micro loans are specifically for those who are investing in their own entrepreneurship. 
  • There are differences in whom these products are aimed at. Payday loans are for those in employment or with a regular monthly income who need to pay an unexpected bill. Micro loans are aimed at entrepreneurs investing in a specific cost for their new business.
  • Remember that payday loans, in every case, will have very unfavourable repayment terms. You’ll often see interest rates at hundreds-of-percent, meaning you’ll pay back loads more than you borrowed. Micro loans offer favourable rates, often with an initial repayment break of several months, too.

Have you got experience with a micro loan? We’d love to hear about it – let us know over on the forums.

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3 years ago

Definitely something worth considering for a quick cash injection to get an idea off the ground.

Jasmine Birtles

Your money-making expert. Financial journalist, TV and radio personality.

Jasmine Birtles

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