How a Lending Circle Helps You Build Credit

Informal lending circles, a form of friends-and-family borrowing, have been around for centuries, embedded in cultures worldwide. They’re known as tandas, susus, cuninhas, hui and pandeiros, depending on where you go.

Here’s how they work and which companies are using this age-old concept to help people build credit.

How a lending circle works

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

The circle consists of a group of people lending money to each other at no or very low cost. The group members collectively decide on the amount to be loaned, say, $1,000. Then each member contributes part of that amount — say $100 apiece — 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 and all the loans will have been totally paid off. 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 consist of people you know and trust.

How to use a lending circle to build credit

Companies such as the nonprofit Mission Asset Fund, mobile app Esusu and website EMoneyPool help participants form lending circles — and build their credit scores.

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A credit score gives you access to financial products from banks and other lenders, and a higher credit score gets you lower rates.

There are no specific requirements to participate in a lending circle except showing that you have a source of income and a manageable amount of debt, says Jose Quinonez, founder and CEO of San Francisco-based Mission Asset Fund, which has facilitated 10,000 loans. If your debt exceeds more than half your income, the organization offers financial education courses on managing your money before you can join a circle, he says.

Esusu is a mobile app where you can sign up and invite people you know to form your own lending circle. The company charges a flat fee of $10 per pay-in cycle.

EMoneyPool is a website that allows anyone to join an online lending circle through linked bank accounts. Members earn trust by successfully participating in the circle. Proving yourself can unlock access to bigger pools of money or allow you to receive the pool of money faster if you have an urgent need.

All three companies report payment activity to one or more of the three major credit bureaus, which allows people with no credit experience or with damaged credit to build a score. Esusu also offers optional rent reporting to members, which means your monthly rent payments are reported to the credit bureaus. Late payments or defaults are also reported to the bureaus, which can negatively affect credit scores.

The lending circle loan shows up as an installment loan on your credit report, says Quinonez. Mission Asset Fund and EMoneyPool back the loans —  if someone in a circle does not pay, the other members do not lose money. Esusu works out a payment plan if someone has difficulty paying, and will back the loan in those cases, says Wemimo Abbey, co-founder of Esusu.

Default rates at Mission Asset Fund are less than 1%, says Quinonez, partly because of the social responsibility that being in such a group entails.

A cheaper alternative to payday loans

A lending circle that helps you build credit is a cheaper, safer way to borrow money than turning to a payday lender.

Payday loans carry very high interest rates, are due in a short period of time and allow rollovers of the loan, all of which can trap you in a cycle of debt.