updated 5/22/2005 5:28:09 PM ET 2005-05-22T21:28:09

One bank told Jay Rice his credit score was "garbage" when he tried to get a loan to start a landscaping business from his home in a run-down section of Miami.

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Fidel Albelo thought he'd do better when he wanted funding to expand his print shop because he had his personal accounts for more than a decade with his bank. He also got turned down — because his credit history wasn't established long enough.

Both men were losing hope in their entrepreneurial dreams until they got lifelines from a microlender, a company that specializes in making small loans to businesses who are rejected by banks and other traditional lenders because of poor credit.

"They've saved my butt, you know what I mean? I would endorse them over any bank. I would endorse them over any financial institution. I would endorse them over any government minority business program," said Rice, who got a $4,000 loan at about 12 percent interest.

Microlenders have been giving small businesses loans of less than $35,000 for about 20 years in the United States in an attempt to help people out of poverty. They focus on businesses with five or fewer employees.

These nonprofit groups are becoming more popular but they are at crossroads. The money that they lend comes from government grants and foundations, whose generosity ebbs and flows with the health of the economy. And they don't have enough customers to be self-sufficient.

They are also facing growing competition from banks and credit card issuers, which are beginning to take on riskier clients as they look to expand revenue.

Some microlenders have begun to merge or diversify by adding products such as investment funds and savings accounts to combat the growing pressures on their business, said Lisa Servon, a senior research fellow at the New America Foundation, a research group.

If "the microenterprise field does not make some significant changes it will neither sustain itself nor approach its potential," she wrote in a report.

The Aspen Institute, a research group in Washington, estimates that 10 million microbusinesses have trouble getting bank financing. But only an estimated 150,000-170,000 people are currently working with lenders and programs designed for microbusinesses. In 2002, there was about $93.6 million in microloans outstanding, with the average business borrowing about $7,000.

Microlending gained popularity in poor countries such as Brazil and Bangladesh, where successes prompted its supporters to try it in the U.S. so the poor wouldn't have to use high-interest credit cards to finance their small businesses.

U.S. microlenders say their interest rates average anywhere from 9 percent to 12 percent. Credit card rates averaged 12.1 percent in the first quarter, but can be closer to 20 percent for those with poor credit histories.

The practice has grown quickly over the past decade as major companies have downsized, more low-skilled immigrants have come to the country and factory jobs have been cut in rural areas, the institute found. There were 108 microlenders in 1992 and are more than 550 now.

But that growth has also hurt because most new microlenders are too small to become efficient enough and reach enough people to pay all their expenses, Servon said.

The biggest microlender in the U.S. is the Accion network, which has about $25 million in loans outstanding to around 2,800 clients, including Rice and Albelo.

Accion may be a nonprofit, but it operates like any other lender, said Bill Burrus, president and chief executive of Accion USA. It tries to collect on the 10 percent of loans that are delinquent, sometimes sending people to collection agencies.

That rate is higher than the around 5 percent for credit cards, according to federal statistics. But despite the higher risk, Accion's overriding mission is still to help people, he said.

Burrus says Accion is approaching self-sufficiency in some cities _ the New York office covers about 80 percent of its costs. That's much higher than average.

About 35 percent of a typical microlender's funding comes from the federal government, with about 22 percent from state and local governments, 27 percent from private sources and the rest from income from fees and interest, according to the Aspen Institute. Microlenders say they are worried that they might lose funding as the federal government tries to plug the growing U.S. deficit.

The Small Business Administration has proposed eliminating funding for its microloan program, which had $15 million in loans last year, said Tee Rowe, the agency's acting associate administrator for congressional affairs. Congress could reject the proposal, but the SBA is proposing to replace it by expanding a much-larger government-guaranteed loan program that commercial banks run, he said. Maximum interest rates were about 12.5 percent in the beginning of May.

The banking industry wants to work with more microbusinesses and plans to add targeted advertising for its services, although banks typically have stricter standards for collateral than microlenders, said James Ballentine, director of community and economic development of the American Bankers Association.

The SBA program guarantees up to 85 percent of loans under $150,000, which should help banks work with more microbusinesses, Rowe said.

Microlenders also try to help clients long enough to establish their credit and then send them to banks. But the prospect of going back to a bank isn't what Rice and Albelo want to hear.

"I'm happy where I am," said Albelo, 46, a Cuban exile who escaped the island nation in 1990.

He started his print shop with $1,200 in savings, but that wasn't enough to buy modern equipment. He had to print T-shirts and posters using a heavy, hand-operated machine.

Then some students of the wrestling coach put him in touch with Accion, which lent him $15,000 at about 12 percent interest. He bought new computers to design his products, and printers and computer-aided sewing machines to make them. He now has about $150,000 in annual sales.

"I was a wrestling coach. I never thought I would do this," he said at his workshop in the Miami suburb of Doral.

Rice, a 39-year-old Navy veteran who served in the first Gulf War, is just as proud about his business. He previously worked in hospital admissions, but didn't find that fulfilling.

His landscaping business had about $8,000 in sales in six months last year after getting Accion's loan and will probably hit $16,000 this year, he said.

"People are scared to go into business. But it's the best freedom to ever get. ... It's a euphoria," he said. "It comes with a lot of aggravation, a lot of hard work, a lot of headaches, but man let me tell you, I should have did this 20 years ago."

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