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Microloans: What is it and how it works?

Have you ever been in the position of needing to do something like renovating a small room, or buying appliances? We all have been there and thanks to nowadays technologies most of us don’t need to go the old route to get a heavy load, instead we can get a microloan!

Not only that, but microloans have gained an important role in startups and entrepreneurs who have encountered obstacles in getting conventional financial services. These loans are here to help you kickstart your businesses, or in the case of the appliances loan to improve your lifestyles, it promotes economic development and independence.

a woman holding several dollar bills
Microloans are a good option for people with no collateral or credit history and in many cases a better option than a traditional loan.

What is a Microloan or Microcredit?

Microloans are fundamentally about creating opportunities. They are usually provided to people without collateral, with a limited credit history, or residing in areas where banks are scarce. Microloans emphasize the potential of each person rather than their financial history, signaling a move towards a more inclusive economy.

For new entrepreneurs microloans can be the key to unlocking new business opportunities, these loans can offer the necessary money to improve your inventory, and equipment, or cover an initial expense. Given the proper concept and some financial backing, microloans have the potential to transform a small business into a successful venture.

Not only that, but microloans work like regular loans to some extent, they can assist individuals in developing countries in launching or growing a business.

Basics of Microloans

Microloans aren’t just about borrowing money, the prices can vary from $50 to $50,000, an amount that can easily meet the requirements of different small-scale entrepreneurs and people, this serves as a pathway to financial freedom for many.

How Do Microloans Work?

The process is simple and easy. You can apply to a microfinance institution like Didigo, or to a credit union (in some cases even to a non-profit organization).

Once your application is accepted, you will receive the funds and a straightforward repayment schedule, and that’s it! Keep in mind that microloans are successful because they are easily accessible, but what most people overlook is the repayment schedule.

What Happens If I Can’t Repay?

If you fail to repay a loan, it can lead to significant repercussions, and that will depend a lot on what kind of agreement you settle, the rates, fees, and any additional costs. The repercussions can be anything from, collection activities, more and more fees, a bad credit score, and in the worst-case scenario the lender may opt for legal action.

Defaulting a loan, normal or micro is never a good idea, that’s why you need to make sure to stay in touch with your lender if you’re having trouble making payments.

Several providers provide restructuring options, and a few might offer grace periods.

Pros and Cons of Microloans

Microloans can be beneficial for many people, but they also come with their own set of disadvantages, similar to other financial products.

Pros of Microloans

Microloans provide financial assistance to individuals who may not qualify for traditional loans, making them easier to obtain.

Moreover, microloans can assist in building a positive credit history, potentially increasing your eligibility for conventional loans if you ever need one.

Cons of Microloans

But, as you might guess, not everything is flawless. One drawback of microloans is the interest rate, which tends to be higher compared to traditional loans.

However, it’s understandable, there is a bigger risk involved in loaning money to people without collateral. There’s a chance that people may end up with more debt than they can handle.

Microloans vs. Traditional Loans

Despite that you may be looking for an alternative to traditional loans in microloans due to credit history or collateral, it’s still important to get a good idea of the differences between microloans and traditional loans to make good financial choices.

The difference and be sum in two main points:

  • Microloans are usually for smaller sums, have more relaxed eligibility criteria, have fewer requirements and usually come with higher interest rates.
  • Conventional loans, in contrast, tend to be larger, you need collateral, and a good credit history, and an application process is usually a lot more stringent.
Different currency bills and banknotes
Unlike traditional loans, microloans can help people in developing countries where bank services are not as good as in other countries.

Which One Is Right for You?

In order to decide between a microloan and a traditional loan, you need to see the full picture, and this decision is based on three points, your financial needs, business goals, and most importantly, eligibility.

Microloans are perfect for you if:

  • You’re just starting
  • You have restricted access to banking services
  • Don’t have collateral
  • Don’t have a credit history

How to Apply for a Microloan

Applying for a microloan is a simple process and pretty straightforward, first, you need to contact an institution and complete the application form.

You usually need to give out your personal information, or business details and a plan that outlining how you will be using the loan.

Required Documentation

Most lenders typically request identification, proof of income, business licenses, and a detailed business plan, although the required documentation may vary. Some might ask for references or credit history, but this is not as typical in microfinance.

Eligibility and Application

Microloans are meant to be easily accessible, yet applicants must still meet certain criteria. It’s important to grasp these requirements for a successful application.

Who Qualifies for a Microloan?

Most of the microloans are for entrepreneurs or small business owners but nowadays you can find microloans for people that need them for day-to-day cases, like appliances, or remodelations.

When it comes to eligibility, microloans are a lot more flexible, helping people from developing countries, without credit history and without collateral or the ones that don’t have easy access to proper banking services.