What are Lending Circles and How do they Work?
In the days before banks, loan companies, and credit card providers, if you wanted to borrow money, you looked to your family members and friends. They gave you the money you needed, you promised to pay them back, and the bond of blood or trust was enough to keep that verbal contract alive.
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This age-old agreement is essentially how lending circles work. There are a few more complications, but the idea is the same: You need money, they have it, and they trust you enough to lend it.
In debt-riddled America, sharing, bartering, and “paying it forward” is becoming increasingly common as our altruistic natures kick in. Lending circles are another aspect of this and could be the perfect solution if you need money or a credit score boost.
How Do Lending Circles Work?
A lending circle is a group of friends, acquaintances or loved ones that agree to deposit a fixed amount into an account every month, with that money then going to one of the group members. Everyone pays the same amount, everyone gets a chance to withdraw, and no one pays a penny in interest.
Think of it like buying a round of drinks down the pub. At the beginning of the night, there are 5 friends, all drinking the same drink that costs the same amount of money. Person A agrees to buy the first round and in doing so he pays 5x more than he would if he just bought his own drink.
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But if everyone plays fair, Person A knows that he won’t need to buy his 2nd, 3rd, 4th, and 5th drinks.
The difference with a lending circle is that you’re getting a cash sum each time and can use this cash to make a necessary purchase, pay some bills, launch a business or make a down payment on a house.
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Understanding a Lending Circle
For the sake of brevity, let’s imagine that you have 11 friends, creating a lending circle of 12 individuals. You sit down for a discussion, run some calculations, and determine that you can all afford to pay $200 a month without seriously impacting your finances.
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Every month, all members pay their $200, totaling $2,400, and this goes to a preselected member. The next month, the same thing happens and it goes to a different person, making sure that every member collects the money once before the cycle repeats.
If you can afford to spend $200 a month, it won’t feel like you’re losing any money. Yet, out of the blue, you’ll get a windfall of $2400.
What’s the Point of a Lending Circle?
If you’re only getting out what you put in, then what’s the point?
You could ask the same thing about loans, only they make even less sense. With a loan, you may receive $2,000, and then pay back $2,500 or $3,000. You always spend more than you gain. With a lending circle, it’s like-for-like.
You can structure a lending circle so that everyone gets their share of the money when they need it most. For example, the individual with the lowest income and the biggest family can receive their share on Thanksgiving or Christmas. The schoolteacher can get theirs during the summer, when they have more time to spend it; the student can get it prior to the start of the semester.
Using a Lending Circle to Build Credit
Everything discussed above supposes that you’re using the most basic form of a lending circle and are doing it purely as a way of combing a savings account with an interest-free loan. But there are other benefits to lending circles and they are increasingly being used to build credit.
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Companies like EMoneyPool and Esusu allow members to create lending circles with strangers, reporting all payments they make to the major credit bureaus. This means members can boost their credit scores without acquiring a high-interest loan or credit card.
There are also rent reporting options offered on the Esusu app, which means you can pass your rent payment history onto the credit bureaus and receive kudos every time you pay your rent.
The Pros of Lending Circles
The main benefit of using a lending circle app or website is credit building. If you have no credit or low credit, it could be one of the few options available for this.
Lending circle payments will show as an installment plan and if someone in the circle fails to meet their obligations, they are offered payment plans so they can keep going.
There is a certain social responsibility to these programs and members don’t want to be seen as the one that fails to pay, which is why Esusu reports that fewer than 1% renege on their promise.
The Cons of Lending Circles
Lending circles that build your credit are not free and can seem a little pointless if you’re depositing small amounts of money. However, the benefits they bring are invaluable and they are much cheaper than payday loans, high-interest credit cards, and other credit-building options.
They’re there to help, but there is still money on the line, there are still commitments to make, contracts to sign. If you fail to meet the repayments, the credit bureaus will find out and your score will suffer, so don’t expect an easy ride and don’t commit to a higher payment than you can afford.
Summary: Joining a Lending Circle
If you’re struggling with bad credit, need a loan, and have some money to spare every month, then we recommend giving lending circles a go. In addition to the options discussed above, you can also join Mission Asset Fund, where participants see an average credit score increase of 168 points.
This site arranges everything, including the payments and the payouts, and it has a wealth of financial education resources to help you budget better and look forward to a brighter, debt-free future once your credit score has improved.