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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.
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?
Say a group of 10 people collectively decides 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. One member gets the full $1,000 each time.
By the 10th month, all participants will have received $1,000.
Benefits of lending circles
They provide small windfalls. Lending circles help participants raise money for various expenses, such as down payments, debts and small-business investments. Participants typically agree to a specific order of payouts to recipients, but they might change it up if a member has an urgent need for cash.
They’re an affordable way to borrow. Unlike most other ways of borrowing, a loan through a lending circle typically carries no fees and no or very low interest, depending on the group’s arrangement.
They can build 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 and gaining access to affordable credit cards and loans.
They provide accountability. 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.
What to ask if you're 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 money immediately?
If your lending circle includes 12 individuals and you're last in line to receive a payout, it could be a year before you 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?
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.
🤓 Nerdy Tip
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 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. In contrast, a lending circle lets you borrow money at no or very low cost, typically from people in your own community. 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
- Small personal loans: Personal loans have stricter requirements than lending circles and annual percentage rates up to 36%. But funding is much faster — typically within a few days. Both borrowing methods can help you build credit if on-time payments are reported to credit bureaus.
- Family loan. Get a low- or no-cost loan from someone you trust. With a family loan, 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.
- 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.
- 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.
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.
» MORE: How to build credit
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