For some new entrepreneurs, finding ways to receive initial funding can be a challenge due to myriad reasons: poor credit, lack of financial connections and more. That’s where microloans provide a valuable service.

Microloans, generally defined as loans of less than $50,000, are oftentimes the first source of capital for small businesses. They can help financially marginalized individuals by providing them with capital to launch their business and work their way toward independence. While microloans can be helpful, they come with risk. Interest rates are often high because the borrower doesn’t have collateral on their business.

In the United States, a lot of microlending is conducted by government-approved institutions, including the United States Small Business Administration, which operates the goal of spurring small business growth. While microloans can be a great way to launch a business with capital, there are some drawbacks to consider. Here are the pros and cons.

Pros

Build credit

Just like a person needs to build credit, so does a business. And if the person behind the business doesn’t have great credit of their own, microloans are a good source of capital. Because the sizes of the loans are often small — the United States Small Business Association reports the average microloan is $13,000 — high credit scores aren’t necessarily a prerequisite.  

Small amounts are also easier to pay back. But that also comes with drawbacks, like a higher interest, as we’ll get to down below.

Higher chance of approval

For business owners struggling to qualify for traditional loans, they will likely fare better with microloans. New businesses might not need much capital to start or they don’t want to go into too much debt, so microlending can be an ideal place.

In considering your application, microloan lenders can look at factors beyond your credit, including your ability to repay the loan and a solid business plan.

Cons

Higher interest rates

Because of low loan amounts, microloans come with high interest rates — sometimes as high as 8%. Rates aren’t as high as a credit card, but they are above what a typical loan would charge. That’s why it’s important to weigh the risks of microlending before diving in head first.

Lack of options

Many microloan lenders are limited to specific regions. Depending on where you live, you may find there are few local options for microloans.