Under the best of circumstances, getting financing for your small business is no sure thing. About 4 in 10 small businesses with less than $1 million in annual revenue were denied financing at small banks, and more than half were rejected at big banks, according to the 2016 Federal Reserve Small Business Credit Survey.
It can be even harder for underserved or less formal small-business owners to access capital. There may be fewer traditional financial institutions like banks or credit unions in your area, or you may have tried to get financing at those institutions but didn’t meet their underwriting or documentation requirements.
If either is the case, you might try your luck with financing from community development financial institutions, or CDFIs. Why? The approval rate for sub-$1 million revenue businesses was better than 75%, the Federal Reserve’s survey shows.
What is a CDFI?
Several types of institutions can serve as a CDFI, including banks, credit unions, loan funds and venture capital funds, according to the CDFI Fund, an arm of the Treasury Department that supports CDFIs through financial and technical-assistance awards.
CDFIs’ goal is to broaden economic opportunity among low-income and minority communities by providing access to basic financial services for individuals and businesses. CDFIs provide a range of financial products, like mortgages for low-income and first-time home buyers and commercial loans for small businesses. About 1,000 CDFIs are in operation across the country.
In the 2016 fiscal year, CDFI Fund awardees loaned or invested $3.62 billion in loans or various programs. Nearly a quarter of that total capital originated small-business loans, the fund says. An additional 21% went to commercial real estate loans.
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Small-business CDFI loans: Pros and cons
Low interest rates: Rates for CDFI loans are competitive with those you will likely find from other sources, such as banks that issue Small Business Administration loans. A study of CDFI financing commissioned by the CDFI Fund found that the median interest rate in 2012 for a CDFI-originated business loan with a 48-month term was 7.75%. In comparison, rates in April 2017 for an SBA 7(a) loan under $25,000 and paid off under seven years were around 8%. Rates for online lenders are generally higher and can reach into the high double digits.
Higher likelihood of approval: CDFIs generally are more likely to extend credit to borrowers that traditional banks would deem too risky, says Ayrianne Parks, a spokeswoman for the CDFI Coalition, a Washington, D.C.-based advocacy group. The proof is in the numbers. According to the Federal Reserve survey, the approval rate for small businesses that applied for loans or lines of credit from CDFIs was 77%. That was higher than at online lenders, credit unions or banks of any size.
Simpler products: The financial products CDFIs offer generally are “plain vanilla,” according to the CDFI Fund study, meaning they’re designed to minimize the borrower’s risk. Most of the loans are fixed-rate, which means the borrower’s payments are predictable. In addition, they’re self-amortizing; as borrowers make payments, they’re paying interest and chipping away at the principal so that the loan is paid off at the end of the term. Origination fees are low, and in many instances, nonexistent.
Business development help: CDFIs offer technical assistance and training programs to small businesses to help them get started and grow sustainably. Some offer mentoring and advisory services.
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Not for everyone: To be certified by the federal government as a CDFI and be eligible for CDFI Fund money, organizations must have a primary mission to promote economic development and must serve an underserved area or population. If your business isn’t lacking resources, opportunity or access to financial services, chances are that a CDFI is not the right path for you.
Longer funding time: The application process and time to funding can take longer at CDFIs than at other types of institutions. CDFIs generally have fewer assets than banks, “so a loan application may be delayed because a CDFI may not have enough bandwidth to fund everything in their pipeline,” Parks wrote in an email. By contrast, online lenders can fund loans in days or weeks.
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Where to find a small-business CDFI loan
To apply for financing, small-business owners likely will need to provide the same kinds of information they would at a bank: personal and business tax returns, personal financial statements for all business owners, lease agreements, bank statements, income statements and balance sheets.
Compare small-business loans
If your business isn’t eligible for a CDFI loan, online lenders may provide an alternative. Online lenders specialize in simplifying the loan application process and in offering credit to a wider variety of businesses at competitive interest rates for strong-credit borrowers and often more quickly than banks.
Updated April 26, 2017.