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Will Getting a Microloan Hurt My Credit Score?

Are you a small-business owner seeking a cash infusion to handle an unexpected cash crunch or take advantage of a new opportunity? Depending on your needs, a microloan could be just what you're looking for.

Microloans are small loans designed specifically for businesses. Much like more traditional loans, defaulting on microloans will negatively affect your credit score, so be sure to choose a loan with payments you can manage. Paying back your microloan on time and in full, however, can help to improve your credit score. Here's a quick guide to understanding microloans and how they affect your credit.

What Is a Microloan?

As the name implies, microloans are very small loans designed for small businesses. How small are the loans? While the average loan for Small Business Administration's flagship 7(a) loan program last year was $446,487, the average SBA Microloan was just $14,735. You can even find microloans as small as a few hundred dollars, which could be all a very small business needs to get through a rough patch.

Given the smaller dollar amounts, applying for microloans is usually faster and easier than applying for more traditional business loans. Microloans, however, generally have shorter terms and often have higher interest rates as well.

A business slowdown can hurt your personal finances too. But it's important to remember that microloans can be used only for business purposes—not for personal expenses or personal debt. Allowable uses for microloans vary depending on the lender. For example, SBA microloans can be used for working capital (such as paying employees); buying business inventory or supplies; or buying machinery, equipment, furniture or fixtures. Microloans cannot be used to pay existing business debt.

If you need money to cover personal expenses, consider applying for a personal loan. Unlike microloans, personal loans can be used for almost anything (although some do have restrictions).

How Microloans Impact Credit

Although microloans are business loans, your personal credit score may affect your ability to get one. That's because a relatively new or very small business, especially a sole proprietorship, may have little or no business credit history. Without a business credit history to go on, lenders will consider your personal credit history when reviewing your microloan application.

As with any type of loan, defaulting on a microloan will negatively affect your credit score. Because many microlenders require a personal guarantee, defaulting can hurt your personal credit score as well as your business credit score.

A microloan application will also trigger a hard inquiry on your credit report, which can cause a temporary dip in your credit score. To minimize any negative effects, concentrate on applying for microloans you're well-qualified for. If you're applying to several lenders to get the best terms, be sure to complete all your applications within a few weeks. Credit bureaus generally treat applications made within that time frame as a single hard inquiry.

How Can You Get a Microloan?

Most microloans come from nonprofit organizations with a mission to help new, small or disadvantaged businesses that might not otherwise qualify for business credit. The SBA's Microloan program is a good place to start. SBA microloans are administered through nonprofit community organizations and are available for $500 to $50,000. Check out the SBA's database of approved microlenders to find one that's right for you.

Outside the SBA program, Accion and Kiva are two of the most popular nonprofit microlenders. Accion loans start as low as $300; Kiva makes loans of up to $15,000 with 0% interest. Each microlender has its own application process, requirements and criteria for applicants. Take the time to research your options and find the microloan that's the best fit for you. Your local SBA district office can help; mentors at SCORE can provide in-person and online advice for free.

The Bottom Line

Microloans can be a good option if you don't qualify for a traditional business loan or don't need the hundreds of thousands of dollars that traditional business loans generally offer. By choosing the right microloan and paying it back on time and in full, you can not only help your business get through a cash crunch, but also help build a strong credit score.

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