Do you sometimes find yourself in need of cash to cover a short-term expense? If so, you may consider relying on a credit card or a personal loan. All these credit sources are in ample supply, however, these loans typically charge extremely high-interest rates. Fortunately, there are other avenues you can explore if you require a short-term cash infusion. One such option is a lending circle.
What Is A Lending Circle?
A lending circle is a group of people who form an association to lend each other money, usually at no cost. They can function as formal or informal organizations.
Informal lending circles have been around for centuries, with individual members made up of friends, family members, or entire communities. Trust between members was based on familiarity and social approbation. The transactions in lending circles were conducted privately and did not affect members’ credit standing and reputation in the broader economy.
Today, lending circles are more formal, with many reporting on members’ on-time payments to credit bureaus, making them ideal for those wanting to establish a good credit history. With the advent of online banking, lending circles have opened up to allow people from various backgrounds and circumstances to participate and access credit safely and cost-effectively.
Lending Circles vs. Peer-to-Peer Lending
Lending circles differ slightly from peer-to-peer networks. In a lending circle, individual members are both lenders and borrowers. With peer-to-peer lending, members are either lenders or borrowers, but not both. To borrow from a peer-to-peer network, you also need to meet more stringent criteria to be eligible, similar to that of a traditional lending institution. Once you’re approved for your desired loan, you usually receive the money immediately, which is not always the case when borrowing from a lending circle.
How Does A Lending Circle Work?
Most lending circles operate in the following way:
Terms – Members agree to what amount they should pitch into the pool, how much they can borrow, and how often they need to pay. If deemed necessary, they may also set fees and an interest rate on borrowed funds.
Contributions – Each member pays a fixed sum into the pool that they agreed upon in the beginning. Payments are made at set intervals, usually once a month.
Lending – Members take turns borrowing the full amount from the pool until each member has borrowed. The borrowing order can be based on a strict agreement or flexible depending on members’ urgent need for money.
For example, ten individuals get together and decide to contribute $200 each month. In the first month, they each pay $200 into the pool for a total of $2,000. The entire amount goes to a preselected member, who can use it to finance a purchase or pay off debt. Next month, the cycle repeats, but a different member gets to keep the $2,000 lump sum.
Borrow Up To $50,000
What Can You Finance Through A Lending Circle?
Though you’re free to spend the money you borrow from a lending circle on anything you want, smaller expenses are your best option, as the borrowed funds essentially amount to a short-term loan, with repayment in full to be made within a year.
Now members usually can only borrow small amounts. Once they’ve gained the other members’ trust by making timely payments, they can borrow larger amounts.
Pros And Cons Of A Lending Circle
Before you decide if participating in a lending circle is right for you, consider the pros and cons.
Pros
- Affordable – Lending circles charge lower interest rates than traditional financial institutions. Some may not charge interest at all, which is incredibly beneficial if you earn a low income.
- Build up your credit score – Some lending circles have started to report member payments to credit bureaus, which means you can utilize them to cultivate a credit history.
- You can create your own – Anyone can create lending circles. Group members personally decide who should join, based on their past experiences, repayment history, and general trustworthiness. Because lending circles are comprised of members who know each other personally, there is a strong incentive to pay back the money on time.
Cons
- Limited access to funds – Lending circles are not the ideal source for borrowing when you have an emergency and need cash immediately. You may have to wait a long time before it’s your turn to borrow, as each cycle in the lending circle only allows one person to use the money in the “pot” at a time.
- Trust building – You may not have the time nor the inclination to establish yourself as a trustworthy and credible member. Lending circles are built on trust and a history of honouring payments. They’re a good fit for individuals wanting to borrow more than once, rather than those looking for a one-time loan; if you fall into the latter category, joining a lending circle is likely not your best choice.
Eligibility Requirements For Lending Circles
Becoming eligible to participate in a lending circle requires three things:
- Income – You must provide proof of a reliable income stream.
- Debt-to-income ratio – In general, your debt-to-income ratio should be less than 50%. Lending circles need assurance that your debt won’t hamper your ability to contribute payments.
- Bank account – A bank account is required to facilitate the easy transfer, tracking, and safekeeping of member contributions.
Bottom Line
Lending circles have been around for a long time and will continue to do so. They’re a popular source of financing for individuals because they provide access to money at a low cost, help individuals build a credit history and function on trust and reliability.
If you feel that joining a lending circle would benefit you, try starting one with your family and friends – they may feel the same way and happily join. If, instead, you’re seeking something more formal, where you can establish a credit history, check online for lending circle organizations and see what they have to offer.
