Borrowing money can be expensive and surprisingly difficult, especially for small-dollar loans you might need for emergencies and surprise expenses. Personal loans through banks and other lenders can be pricey—interest rates are currently around 12% for these kinds of loans, and they often come with other costs like application fees and origination fees; the latter can be as high as 10% of the loan’s value.
Folks with bad credit often turn to bad ideas like payday loans or credit card cash advances, which are exorbitantly expensive and often difficult to pay off. And even people with good credit can struggle to get a loan these days—it’s getting harder to even get a loan. Whether you’re struggling with a bad credit score or just looking to get cheaper access to small-dollar loans, there’s an alternative you should definitely consider: lending circles.
A lending circle is an old idea, and a simple concept: A group of people agree to contribute a specific amount of money to a pool on a regular basis (typically monthly). One member receives the total pooled amount once every period (typically annually) as a loan with a simple repayment schedule (say 24 months). They're a simple form of peer-to-peer lending.
For example, Louis DeNicola wrote on Experian’s blog about his lending circle experience. The one he joined had 12 participants and he contributed $200 per month to the fund. When his turn came, he got a $2,400 loan with a 12-month repayment term.
Lending circles can be informal—you can create one right now, with any number of people (friends, relatives, or anyone else)—or more formal through an organization. And if you ever find yourself needing a small loan to pay off big expenses or get you through rough patches—even if you have good credit—there are a lot of reasons to consider starting or joining one.
A lending circle can offer several potential benefits:
Zero-interest loans. Lending circle loans are interest-free and usually have no fees associated with them (some organizations that formalize lending circles do charge fees, however, so be sure to research potential partners). You pay your monthly contribution, you receive the pool when it’s your turn, you pay it back. Lending circles are usually the cheapest option for small-dollar loans.
Builds credit. Lending circles can potentially help your credit score—if they are formalized with loan agreements and operated through an organization that reports to credit bureaus. In that case, they’re counted as installment loans and can improve your credit mix, and the repayment will help shore up your overall score—plus, there are no hard credit checks that can ding your score. If your lending circle is informal, however, it won’t have any impact on your credit score.
Acts as a savings plan. If you struggle to save money, the social pressure of joining a lending circle can incentivize you to contribute every month, and when you receive your lump sum, you can tuck it away in your savings account.
Guaranteed payout. Most lending circles randomize the order in which members receive the pooled money, but you know you’ll get your turn eventually. Many circles allow members to trade places or make hardship requests to jump the line, as well, so you can bump up your payout if an emergency arises.
Lending circles aren’t without some downsides and risks, however:
Money up front. Lending circles require you to pay in first, and often have strict membership requirements. If you need money immediately, they’re not a good fit.
Trust-based. Informal lending circles operate on trust and social connections, which means they can fail if one or more members fail to honor their obligation to contribute. It also means there’s always the possibility that someone might luck into an early payout and simply walk away with the money—and the laws around these arrangements can be murky.
No interest. The money you contribute to a lending circle doesn’t earn interest; depending on your situation, putting that money into a savings account might be a better decision.
Inflexible. The amount of the loan you receive, the schedule for getting it, and the terms of repayment are usually fixed in a lending circle. While you might be able to move up in the schedule if you have an emergency, you might not be able to, meaning that you can’t get access to the funds when you need them.
If you think you could benefit from belonging to a lending circle, you can form your own simply by contacting trusted individuals and making the arrangements. Most lending circles have six to 12 members, and the amount each member contributes each month, the loan schedule, and the repayment terms are up to you. Some lending circles require up-front payments of just $5-10 per month, while others can require thousands of dollars be deposited each month. You don’t need any formal paperwork, although you can, of course, create simple contracts if you want to.
If you want something more formal, you can look for lending circles administered by the Mission Asset Fund (MAF), a nonprofit organization based in San Francisco that works to help low-income families build credit. The MAF offers lending circles around the country, and has an online search tool that can help you locate one near you and apply for membership. Their lending circles also report to the three major credit bureaus (Experian, TransUnion, and Equifax).
