Let’s say you’ve decided to start biking to work. There’s just one problem: you don’t have the money for a new bike at the moment. You’ve thought about asking your family or friends for a loan, but you’re afraid that would put a strain on your relationship.
But what if you had a whole group of family and friends with a pre-existing agreement to share money with each other regularly? Then you wouldn’t have to ask for anything. You’d just be accepting your fair share of the cash pool that you’ve already paid into.
This is the idea behind lending circles. These are small lending groups that help all their members raise cash for both regular and unplanned expenses.
What Is a Lending Circle?
The idea behind a lending circle is simple. A group of people agree to contribute regularly to a pool of money and give it all to one group member. For instance, a group of 10 people could decide to put in $60 each every three weeks. Then one of them would collect the full $600.
This arrangement provides each member, in turn, with a small cash windfall. They can put this money to all sorts of uses, such as:
- Taking a vacation
- Helping to pay for a wedding or other one-time event
- Paying down debt, such as credit card debt or student loans
- Building an emergency fund
- Making a down payment on a car
- Making a large purchase, such as a new appliance
- Starting a small business or investing in an existing one
Lending circles have been around for hundreds of years and exist in cultures all over the world. They go by a variety of names, including “tandas” in Latin America, “susus” in West Africa, “hui” in parts of Asia, and “partnerhand” in the West Indies. More modern terms for them are rotational savings clubs or rotational savings and credit associations.
Some lending circles are just casual agreements between friends. These informal lending circles work because the members know and trust each other. But today, new technologies allow arrangements like this to work even with people who don’t know each other well.
How Lending Circles Work
Running a lending circle involves three basic steps:
- Set the Terms. At their first meeting, the members agree on terms. They decide how much each of them wants to borrow, how much each will contribute toward the loan, and how often they’ll make payments. Typically, each member makes the same payment and receives the same payout, but group members can agree to different terms. They can also opt to include interest or fees on their informal loans, though most groups don’t.
- Make Contributions. Say you have a group of 12 people with a loan amount of $1,200, distributed monthly. They have agreed to divide this amount up equally. So, at each monthly meeting, each person puts $100 into the pot.
- Take Turns Collecting. The $1,200 total goes to a different member each month until everyone has had a turn. In this example, each member would get the money once per year. There’s usually a set order for payments, but the group can agree to change it if one member has an urgent need for the money.
Effectively, the members of a lending circle are taking turns making loans to each other. All the members who put in money are the lenders and the one who receives it is the borrower.
However, this arrangement is different from most types of loans. There’s no financial institution involved, and in most cases, there’s no interest or fees. The amount each member collects — $1,200 per year — is exactly the same as the amount they contribute.
Some lending circles are temporary. They continue until each member has received one payout and then disband. Others are ongoing, with members continuing to make new loans to each other every year.
Online Lending Circles
Traditional lending circles meet in person to exchange the money. However, nowadays it’s possible to set up a lending circle online through a company like Mission Asset Fund (MAF) or Esusu. Through these companies, you can form a group with either friends or strangers.
To join a group online, you must provide your bank account details. You may also have to provide proof of income and show that your debt to income ratio (DTI) isn’t too high. This ensures that everyone in the group can handle the monthly payments.
The biggest perk of online lending circles is that they help members build credit. The companies report all the monthly payments into the circle to the credit bureaus so they can show up on members’ credit reports. This can help you build a credit history or improve a bad credit score.
Pros & Cons of Lending Circles
Lending circles are quite different from other types of loans. That’s an advantage in some ways and a disadvantage in others.
Pros of Lending Circles
Using a lending circle offers perks for both borrowers and lenders. These include:
- Low Cost. Lending circles are among the cheapest ways to borrow money. A loan from an informal lending circle has no interest and no fees. Some online platforms charge a monthly fee, but it’s not that high.
- No Hassle. You don’t have to jump through any hoops to borrow money in a lending circle. There’s no need to compare interest rates or fill out loan applications.
- No Credit Check. You don’t need a good credit score to get a loan from a lending circle. Trust between borrower and lender is based on social connection, not credit history. However, online platforms may keep track of borrowers’ repayment history.
- Flexibility. The group members get to decide on the terms of the loans they make. They can settle on a loan amount and payback terms that work for everyone in the group.
- A Way to Build Credit. It’s tough to build credit without a credit card. But if you have no credit history, it’s hard to get one. Online rotational savings clubs offer a way out of the Catch-22, letting you build credit without having a credit score already.
- Social Trust. Most lending circles are groups of people who know each other. That creates trust between borrowers and lenders. All members have a strong incentive to pay back their loans because they don’t want to harm their relationship with the other group members.
Cons of Lending Circles
A lending circle isn’t always the best way to borrow money. The downsides include:
- Small Loan Amounts. Most lending circle loans are quite small. At most, you can only borrow a thousand or two this way. That’s not enough for, say, a new car or a down payment on a house.
- Limited Access to Funds. You can’t just get a loan from a lending circle whenever you need one. You have to wait for your turn to receive the money. You may be able to convince the group to give you your payout early in an emergency, but you can’t get more than one loan in each rotation.
- Up-Front Payments. With most loans, you get your money up front and then pay it back. With a lending circle, you might have to pay in for several months ahead of time before you can collect your cash.
- Fees. If you use an online platform to build your lending circle, it may come with a monthly fee. For instance, Esusu charges each group a fee of $10 per payment period. That’s not a lot, but it’s a significant percentage if your loan amount is small.
- Membership Requirements. Although lending circle loans are generally easy to get, they’re not guaranteed. If you use an online platform, you may need to provide proof of income and a low DTI.
- Financial Penalties in Online Lending Circles. Online platforms can charge extra fees for late payments. They also report these late payments to the credit bureaus. If you fail to pay back your loan on time, you could harm your credit score instead of helping it.
Is a Lending Circle Right for You?
It’s almost misleading to call a lending circle payout a loan. With this type of group, you can’t borrow money whenever you need it and pay it back over time. You have to start paying in money at once, and you don’t receive any until it’s your turn. This isn’t very helpful if you need cash right away to deal with an unplanned expense.
The alternative name, “rotational savings club,” is a more accurate description of what these groups are good for. They’re more like a tool for saving rather than borrowing.
A little simple math shows why. If you put $100 into a lending circle every month and get out $1,200 once a year, the result is the same as if you’d put $100 into a bank account each month and withdrawn the $1,200 after a year. In fact, you’d actually be better off using a bank account, because you’d earn interest on your deposits.
However, some people have a hard time saving this way. If there’s money in their account, they’re always tempted to dip into it. A lending circle forces you to save by taking the money out of your hands. It guarantees that you’ll actually get your $1,200 when it’s your turn, instead of frittering away the extra $100 month after month.
This makes a lending circle a handy way to save for recurring expenses that you know will come up every year. For instance, you could use it to cover the cost of your holiday gifts or your annual summer vacation. Or you could use it to pay yearly expenses for a small business.
A modern, online lending circle is also a useful tool for building credit. It allows you to get a small, manageable loan and pay it off at a steady rate, with no interest and low fees. That’s one of the easiest ways there is to create a credit history for yourself if you don’t have one.
Alternatives to Lending Circles
In short, a lending circle is good for recurring expenses but not great for emergencies. Fortunately, there are plenty of other ways to raise cash in a crisis.
- Earn Extra Income. There are several ways to make extra money in a hurry. You can cash in credit card rewards, sell unwanted belongings, or sell your own plasma or sperm. Other methods, like getting a side gig, can bring in more money but take longer.
- Seek Out Aid Programs. There are all kinds of charities, nonprofits, and government programs that offer financial assistance to people in need. Good places to start searching for help include Benefits.gov and 211.org.
- Get Help from Friends or Family. You can turn to family and friends for help, but be careful. Owing money to a friend or relative can be an uncomfortable situation for both of you. It helps to draw up a loan agreement and keep things businesslike.
- Set Up a Crowdfunding Page. Platforms such as Kickstarter and GoFundMe can help you raise money from both friends and strangers, for emergency use or for any kind of project. There are also equity crowdfunding platforms that help you find investors for business ventures.
- Ask for an Advance. See if your employer is willing to give you an advance on your pay — essentially, an early paycheck for the work you’ve already done. If not, you can get one through a payroll advance app.
- Apply for a Personal Loan. Banks and credit unions offer personal loans for amounts ranging from $1,500 to $100,000. With good credit, interest rates can be as low as 3% APR.
- Get a Small Business Loan. If you need money for business purposes, consider a small business loan. These loans can be much larger than personal loans — thousands or even millions of dollars — but their interest rates are nearly as low.
- Use Peer-to-Peer Lending. Like a lending circle loan, a peer-to-peer (P2P) loan is funded by individuals. However, the borrowers and lenders aren’t the same people and don’t know each other. You can apply for P2P loans through platforms like Prosper.
One option to avoid is payday loans. These predatory loans charge exorbitant interest rates. Many borrowers have trouble paying them back and end up having to renew them, trapping them in a cycle of debt.
There are alternatives to lending circles for building credit, as well. You can use a secured credit card or a credit builder loan. A relative can cosign a loan with you or make you an authorized user on their account. Some payroll advance apps also have features to help you build credit. And services like Experian Boost help you earn credit for paying rent and bills on time.
Lending Circle FAQs
Still not sure if a lending circle is right for you? Here are a few more things you might want to know before taking the plunge.
How Much Can I Borrow From a Lending Circle?
In an informal lending circle, that’s entirely up to the group. You can choose any amount that fits the needs of all the participants. However, some online platforms have rules limiting the loan amount.
With MAF, loans can be any amount from $300 to $2,400. Monthly payments are typically between $50 and $200 per person. Esusu does not have strict requirements, but it says groups usually work best lending $500 to $2,000 per month over a period of at least six months.
Where Can I Find a Lending Circle?
Mission Asset Fund has an online tool to help you find a lending circle in your area. Once you find one, you must fill out an online application and complete an online financial education course. Then you can join a group and choose your own loan amount and where you want to be in the rotation.
You can also use Esusu to set up a new lending circle with a group of friends, relatives, or coworkers. Download the app and choose the number of group members, payment amount, and payment frequency. Then use the app to invite members to join the group.
Finally, if you have a group of friends who live in the same area and can meet regularly in person, you can set up an informal lending circle without using an app. Then you have complete freedom to set your own loan terms.
Can I Get a Business Loan From a Lending Circle?
With a lending circle, there’s no rigid distinction between a business loan and a personal loan. When it’s your turn to receive a payout, you can use the funds for anything you want. You can even use them for business purposes in one cycle and for personal needs in the next.
A lending circle is a useful way to finance regular, recurring expenses. It’s especially handy if you have trouble keeping your hands off the money in your bank account. By treating your monthly payments to the group as a regular expense, you trick yourself into saving.
However, if you’re in need of quick cash in an emergency, a lending group isn’t the best way to get it. In these situations, alternatives like aid programs, payroll advances, and personal loans are a better bet.