Should You Take Out a Business Loan from a CDFI?
Merchants looking for a business loan are often faced with a difficult choice: apply for a bank loan (which are low-cost but time-consuming and hard to get) or an online loan (which have higher approval rates and faster applications but can be very expensive). If your business is community-oriented business, however, you might have a third option: applying for a loan from a Community Development Financial Institution (or CDFI, for short).
CDFIs, not-for-profit financial institutions dedicated to facilitating community growth in disadvantaged areas, are a useful and often overlooked financial tool for certain types of businesses. They’re typically easier to qualify for than bank loans, but carry fewer fees than other sources of financing.
Is a CDFI right for your business? Where do you find one? And what should you look out for? Keep reading to find out!
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What Is a CDFI?
Short for Community Development Financial Institution, CDFIs are financial institutions with a mission to facilitate community growth by providing financial assistance to businesses and consumers in low-income or disadvantaged areas. CDFIs, typically not-for-profit or nonprofit, can include these institutions:
- Credit unions
- Loan funds
- Venture capitalists
In their modern form, CDFIs have existed since 1973. Currently, there are over 1,000 CDFIs in operation and they have loaned more than $2M to businesses and consumers since 1994.
Given the focus on community, you won’t be surprised to hear that most CDFIs don’t operate on a national scale. The CDFIs you have access to will vary depending on the area you live in.
Specific loan products, borrower qualifications, additional services, and other factors vary by institution, but in general, CDFIs come with many benefits.
Women- and Minority-Friendly
Although lenders, on the whole, are making progress toward becoming unbiased (in part due to the increased reliance on technology), studies show that banks and other lenders still favor white men over women and minorities.
Due to a lack of finance opportunities from traditional sources, many women and minority business owners are tempted to borrow from risky, high-interest lenders. A CDFI is a much safer bet.
Many CDFIs are aware of the lending disparity, as well as the importance of women and minority owned businesses, and seek to fill the gaps left by other lenders. CDFIs may offer loan programs specifically for women and minority borrowers, create products that solve common problems experienced by women and minority-owned businesses, offer educational programs for such businesses, and/or simply take steps to ensure that their underwriting practices do not create bias against certain groups of people.
Typically, startups have a difficult time finding financing. Because young businesses have not yet proven their stability, financing a startup is considered risky—and most traditional lenders are not willing to take that risk. However, as the Opportunity Finance Network (a group of over 200 CDFIs) states, “We see possibilities where others see risk.”
Many CDFIs are willing to extend money to startups, incubator businesses, or other very young businesses. You will still have to prove that you’re creditworthy, but newness is not necessarily a barrier to achieving financing.
Relatively Low Rates and Fees
Although CDFIs tend to carry higher interest rates and fees than bank loans, they typically have lower rates than other loan sources, such as online lenders, credit cards, or payday lenders.
According to the CDFIs we surveyed, you can typically expect CDFI interest rates to range from about 8% – 22% APR. Here is how CDFI rates compare to other sources of financing:
- Banks and Credit Unions: 4% – 9%
- CDFIs: 8% – 22%
- Online Installment Lenders (such as Fundation and Lending Club): 6% – 36%
- Personal and Business Credit Cards: 12% – 30%
- Online Merchant Cash Advances and Short-Term Loans: 6% – 99%+
- Payday Loans: Up to 400%
CDFIs are often cited as an affordable alternative to short-term loans, merchant cash advances, or payday loans. As you can see, CDFIs usually have significantly lower fees than the alternatives.
It’s worth noting that, if your business is struggling from high-cost debt, many CDFIs offer refinancing programs. You might be able to replace you high-interest or frequent payment debt for a loan with lower interest or fewer payments. Head over to our Complete Guide to Refinancing Small Business Debt to learn more about refinancing.
Flexible Borrower Qualifications
If you can’t get a loan from other sources—due to low (or nonexistant) credit scores, no collateral, or some other reason—you might be able to get a loan from a CDFI. You’ll still have to prove that you’re creditworthy, but CDFIs can often work with businesses that would be turned away from traditional financial institutions.
Many CDFIs do more than lend money; they also offer educational services on business and financial topics. Some stipulate that you attend the educational programs in order to receive a business loan, whereas other simply offer the programs as an additional community service. Regardless, CDFI educational programs might be able to help you bring your business to the next level.
CDFIs are a useful resource, but some businesses might want to look elsewhere for financing for a number of reasons.
Higher Rates than Banks
As stated above, CDFIs are lower cost than financial products from other sources, but their rates still tend to be higher than those of bank loans. Merchants who have strong, creditworthy businesses should see if they qualify for a loan from a bank or credit union before seeking out a CDFI in their area.
Long Application Process
The length of the application process will vary according to the CDFI, your business, and the time it takes you to gather the necessary documents. Regardless, CDFI application processes tend to take longer than those of some other business loan sources (such as online installment loans or short-term loans).
The whole application procedure could take anywhere between 14 days and two months. In addition to asking about personal and business information, lenders will request to see a number of business documents. Each lender asks for different documents, but the following are commonly required:
- Bank statements
- Tax returns
- Legal documents
- Profit and loss statements
- Balance sheets
- Debt schedule
- A/R aging report
Some CDFIs might list the required documents on their website. The sooner you’ll be able to gather the necessary documents, the faster the application process will go.
Services Vary by Location
Most CDFIs operate on a local scale. The products and services you have access to will vary depending on the area you live in.
That said, there are over 1,000 CDFIs operating around the United States. Chances are, you will have access to at least a few financiers that can help out your business via loans, other financial products, webinars and educational programs, or other services.
Finding a CDFI
Although they are often overlooked, CDFIs are a useful tool for small businesses across the nation. Even if you run a business that is traditionally underserved (such as a woman- or minority-owned business or a startup), a CDFI might be able to extend financing to your business.
Check out these sources for more information on CDFIs:
- Opportunity Finance Network: A network of over 200 CDFIs.
- CDFI Coalition: An advocate and support service for CDFIs.
- CDFI Fund: A government program responsible for certifying and providing assistance to CDFIs.
- Locate the CDFIs in your area via the the Opportunity Finance Network or Bank of America websites