What Is a Lending Circle and How Does It Work?

A lending circle is a centuries-old lending method in which a group of people, usually family or friends, regularly pool a specific amount of money and give it to one member of the group. This continues in a cycle until all members receive a payout from the collective pot of money.

Lending circles are customary in cultures around the world and known as tandas, sou-sous or hui, depending on where you go.

This method of lending and borrowing is popular because the money can be interest-free and helps members pay for emergencies or planned expenses. These days, lending circle participants can even build credit.

How does a lending circle work?

Lending circles help participants raise money for various expenses, such as down payments, debts and small-business investments.

Say a group of 10 collectively decide on a loan amount of $1,000. Each member contributes an equal part of that amount — $100 apiece in this scenario — to the pool of funds every month, and one member gets the full $1,000 each time.

Informal lending circles agree to an order of payouts, which can change if one member has an urgent need for the money.

By the 10th month, all participants will have received $1,000. The loan carries no fees and no or very low interest, depending on the group’s arrangement.

There is a strong social incentive to pay back the loan successfully, because lending circles often consist of people you know and trust.

Requirements for participating in a lending circle

Participants in a lending circle don’t typically need to meet a credit score requirement, but they should have a steady source of income. They also need to commit to regular contributions to the shared pot until everyone in the lending circle has received a distribution.

If you sign up to participate in a lending circle through a third-party organization, you may be asked to fill out an application and show proof of income, identification and a checking account.

Lending circles vs. personal loans

Both lending circles and personal loans require you to pay a set amount of money in regular installments. However, when you participate in a lending circle, it could be months before you receive a payoff. When you get a personal loan, the lender disburses money into your account typically within a week after loan approval — and before you have to make any payment yourself.

Personal loans usually have stricter requirements than lending circles, and they come with annual percentage rates up to 36%. Both borrowing methods can help you build credit if on-time payments are reported to credit bureaus.

» MORE: Best personal installment loans

Lending circles vs. payday loans

Lending circles and payday loans both have low requirements compared to other borrowing methods. Your credit isn’t a factor in determining approval; all you need is a steady income source.

Lending circles and payday loans differ drastically in their cost and how you receive the money and make payments. A payday loan is a high-cost method of borrowing with fees ranging from $15 to $30 per $100 you borrow. You can receive the loan the same day you’re approved and must repay it in full in two weeks to a month.

Lending circles, on the other hand, can be a no-cost way to borrow. You contribute to the pool of money each month, though you must wait your turn to receive a payout.

How a lending circle can build your credit

There are companies and organizations, such as the nonprofit Mission Asset Fund, that help participants form lending circles and report their payments to the three major credit bureaus. Making on-time payments is a big factor in building credit scores.

A credit score gives you access to financial products like loans and credit cards, and a higher credit score gets you lower interest rates.

What to ask yourself when considering a lending circle

A lending circle can be a solid option for borrowing money at no cost, even if you have bad credit (a score between 300 to high 500s) or no credit score. However, here are a few things to ask yourself before deciding to go this route.

Do you need the money immediately?

You’re not guaranteed to receive money from a lending circle in a timely manner. If your lending circle includes 12 individuals, you may wait almost a year before receiving a payout if you’re one of the last people in the group to receive a distribution. If you need a loan fast, a lending circle may not be your best option.

Can you afford to make regular contributions?

A lending circle cannot function properly unless each participant makes regular contributions to the collective pool of money. If you, or another member of the group, isn’t able to contribute, it lowers the expected distribution amount.

Are there legal protections in place?

Similar to family loans, lending circles are often informal borrowing arrangements upheld by a sense of social obligation rather than a legally binding contract. More formalized programs, such as lending circles formed by Mission Asset Fund, may pool the money in a federally insured account and require participants to sign loan documents.

Lending circle alternatives

Because they’re interest-free, lending circles are among the least expensive ways to borrow money. Compare them to other borrowing and credit-building options.

Other ways to get cash

• Help for basic needs. Local financial assistance programs through nonprofits, charities and religious organizations can help you get food, clothing and transportation. If you’re struggling to cover living expenses, contact your utility company, landlord or mortgage issuer to defer a payment, or reach out to a housing counselor for long-term help.

• Family loan. Get a low- or no-cost loan from someone you trust. You and the lender can draw up a repayment plan, including payment amounts and how the money will be used. Mixing money and relationships can be risky, so be sure both parties are comfortable with the agreement.

• Paycheck advance. Ask your employer for early access to your paycheck, or use a cash advance app to borrow from your future earnings. These apps often charge little to no fees. Cashing in early means you won’t get your full paycheck on payday, so check your budget to ensure you won’t miss any bill payments.

• Other ways to make money. You can make money selling clothes, freelancing or driving for a rideshare service. Though there’s no interest involved, this option may require the luxury of time.

» MORE: Explore alternatives to payday loans

Other ways to build credit

• Secured credit card. Secured credit cards require a cash deposit that’s usually the amount of your credit line. The issuer holds the deposit in case you don’t pay the bill, and reports payments to the credit bureaus as you use the card and pay it off. You get the deposit back once you close the account. You don’t need good credit to get a secured credit card.

• Credit-builder loan. A credit-builder loan forces you to save money while building credit. A lender holds onto the amount you want to borrow while you make payments. The lender reports the payments to the credit bureaus and releases the money after you’ve paid off the loan. Credit unions and community banks offer credit-builder loans.