Peer to Peer Lending: I kind of love it

I’m in the early stages of building out a Lending Club portfolio and I freaking love it.  This is seriously a great concept.  I know a couple people who have used it from the debtor side to refinance credit card debt and it seems to really work!  If you’re on the investment side, it’s absolutely awesome.  Sure, there is risk of defaults and losing your principal but overall, I’m really impressed so far.

Right now, I’ve had $1000 in my Lending Club account for just over a month.  In that time, I’ve earned $8.25 in interest.  Significantly better than my Capital One 360 account (Affiliate Link! Open an account and I will in fact get paid.) but significantly more risk.  My savings account is FDIC insured while Lending Club loans are just that, loans.  What’s more, they are unsecured loans.  This means that if the customer goes bankrupt, Lending Club and the investors in the loan cannot go and try to take any specific assets from the debtor.  You see, there is a hierarchy of loans.  The secured loans, held by a bank, are typically first.  The bank holds a the mortgage on your house or the loan of your car.  That means the loans are secured by those debts.  Credit Cards, like Lending Club, are unsecured debts.  This is one of the reasons for the super high interest rates on credit cards, as well as some of the higher interest rates on Lending Club.

So Lending Club is pretty risky.  You’re basically reviewing individuals credit scores, work history, incomes and trying to figure out if they are going to be able to pay or if they are going to default.  The lower the credit grade from Lending Club, the higher the likelihood that the loan will default.  It’s one of the reasons you could build a portfolio of loans that are all at 20% but Lending Club will estimate you’ll actually only make 12% (still a fantastic return in the long run).  But there are ways, of course, to make a better return.  If you’re up for a challenge, you can download statistical data about every loan Lending Club has ever disbursed.  It will tell you everything about the borrower and then what happened to the loan.  You can search the parameters and find certain high interest rate segments that tend to not default, giving you a better long term rate of return.  It’s kind of like a game, except you make money off it.  Who ever said that degree in Economics and the passing grade in Statistics was never gonna be useful???

Ohhhh Pens!

Ohhhh Pens!

Before you get into actually investing in Lending Club, here are a couple of things you should know:

1.  Never put more than $25 into a loan.  The minimum amount you can directly invest in a new loan is $25.  It’s my personal opinion that you don’t invest more than that. If you do, it’ll make it more difficult to potentially sell on the open market, FolioFN.

2.  Never buy multiples of the same loan.  In loan portfolio theory, you want good diversification among loans and credit scores.  If you buy multiple loans from the same source, the expected default frequency (EDF) of your portfolio will go up, potentially decreasing your returns.

3.  Don’t buy only the low grade notes.  I’ve seen some people make this mistake and ultimately get burned for it.  While my portfolio is pretty heavily skewed towards the higher interest rate loans, I still have about 40% of my portfolio in high grade loans that yield between 6% and 9%.  The reason for this is protection.  If I only had the worst rated credits in my portfolio, I could expect a default rate of probably 20%.  Instead, I’ve weighted it using certain criteria, as well as some advanced statistical analysis and backtesting, so create a portfolio with a less than 4% EDF.  The yield of the portfolio, even with this EDF, will be about 15% when it’s all said and done, giving me a good rate of return even with 40% of the portfolio in high grade notes.

4.  Always look at the story behind the loan.  Does it seem believable?  Are they refinancing their credit card or are they building an addition on their house?  Is their income verified?  Do they have a job?  How long have they had the job?  You should know all of this before you purchase a loan.

I think that Lending Club is going to become a fun segment of my investment strategy.  It’s a bit more active than some of my other investments and, oddly enough, I really enjoy it.  If you want to start out but aren’t sure what to do, feel free to send me an email. I can walk you through the setup process or point you in the direction of some good literature focusing on the topic.  Until next time!


DISCLAIMER:  This post and any comments are not legal, investment, or professional advice.  Depending on which state you’re in, this post may be useless to you and will probably suck to read (sorry Texas).  You’ve been warned