Okay, so Peer-to-Peer (P2P) lending is not today’s news. It’s been around for quite a few years already. But that doesn’t mean I cannot share my fresh experience here. I just hopped on to Lending Club like 2 months ago. And I’m finding it very good to recommend to others.
When the stock market is based on a weak economy, gold and silver are at their all time highs, oil/energy is stagnant, and Savings and CDs pay peanuts, P2P Lending provides an excellent investment alternative with a return easily above 9%.
Peer-to-Peer (P2P) Lending
Long story short, P2P lending is a lending platform on which people who have extra cash can lend to needy borrowers at a very favorable rate. Investors reduce their risks by lending the smallest amount allowed to each individual borrower($25), reducing the overall risk of defaults. Borrowers save money on interest borrowing at rates lower than their credit cards. The P2P Lending company makes the money by cutting out the middleman(namely, the blood sucking banks) and charging members fees on transactions. In this article, I’ll only speak about Lendingclub.com from the perspective of an investor.
Lending Club or Propser
Regarding other competing websites such as Prosper.com and how they compare, you can easily do research and find out more. There was a time when these 2 major P2P lenders caught the attention of the SEC. And Lendingclub was the first to proactively shut down its operations and registered with SEC, while Prosper waited until SEC forced them to shut down. Eventually Prosper took longer to register with SEC and resume its operations. Just from that I see Lendingclub as a more responsible company. Lendingclub also has a lower default rate. Check out more details at: http://www.sociallending.net/reviews/lending-club-versus-prosper
Mindset
The first reactions that the majority of people had when I brought up this topic was to ridicule about it. For these people, they think that relying on mutual fund managers or bankers to make $ for them is more safe. Look at what the bankers have gotten the country into. Instead, I encourage you to be more open and evolve with emerging technologies. Having more choices definitely helps with diversification. However, I wouldn’t think any one should put more than 20% of portfolio into P2P Lending.
Why investing with Lendingclub is safe
Diversification
The risk of loan defaults is reduced when investors consistently lend the minimum amount to each loan application(i.e., $25).
10% Loan Approval Rate
Lendingclub only approves 10% of loan applications. With its rigorous loan approval process, sometimes you may decide to lend to a borrower but end up being rejected because the loan failed the approval process.
SEC Filings
Lendingclub is under a certain degree of SEC monitoring. Regularly Lendingclub files information with the SEC to remain compliant with regulations.
2-3% loan default rate
Thanks to the low loan approval rate, the average loan default rate on Lendingclub is about 2-3%. If you work towards achieving a good rate of return with the default rate already taken into consideration, loan defaults should not be a problem whatsoever.
Collection Agencies
No matter how selective you are with lending out the money, you’ll most likely end up with some loan defaults. Lendingclub works with collection agencies to recover the money.
Income based on transactions
Lendingclub’s income is based on loan transactions but not holding onto your money. For that reason, even though there is no FDIC protection, it is really irrelevant once your money is lent out to the borrowers.
Backup Administrator
Lendingclub has arranged for a 3rd party administrator to pick up the responsibilities of loan administration in the event that Lendingclub goes out of business.
Note Trading
Lendingclub also offers the ability to trade your notes(the loan you made to the borrower) if you want to cash them out before their maturity. But if the reason behind trading your note is because the borrower is defaulting or missed some payments, you’re gonna have to offer your note at a bargain.
My Criteria
You use a list of filters to narrow down to those loan applicants that meet your criteria. Bear in mind that most of the information such as Employer or Length of Employment is *NOT* verified. Keep a sane mind about what information provided to you is verified and what’s not. The following is my loan selection criteria.
Verified Income
The loan applicants’ ability to make $ and pay up is the most critical factor. I don’t see how I will invest without this filter.
Revolving Credit Balance < $15000
This is the total amount of credit card balances the loan applicant currently owes. I generally set this to “Under $15,000”.
Max Loan Amount Up To $25000
Many others including myself advocate that one should not lend to those borrowing the maximum amount of money allowable by the system(currently $35000). This is because some people try to max out the money right before declaring bankruptcy. So to avoid that slim possibility, I only lend to those borrowing no more than $25000.
Max Debt-To-Income Ratio <= 20%
This simply shows how much of the borrower’s income is used currently to pay down debts. The lower it is, the better. I keep this filter under 20%.
Income >= $5000
I only lend to those making more than $5000/month, unless the resulting monthly payment is really low. There’s not a filter for this though.
Delinquencies (Last 2 yrs) = 0
I expect the applicant to have never been delinquent in the last 2 years.
Months Since Last Delinquency = 60
Preferably I only want those who have never been delinquent, but there’s not such a filter.
Exclude Relisted Loans
This will filter out those approved loans that couldn’t gather enough interested lenders and eventually failed the funding process. That can be an indicator that something is wrong with the applicant.
Exclude Loans Already Invested In
This will make sure that you don’t accidentally fund more money into the same loan.
Min Length of Employment = 2 years
I wanna make sure that the applicant has been with the job for at least 2 years. Longer tenure with the employer is a good sign of job security.
With this, I currently make a return of 11.76%!
Filters that I don’t care about
Home Ownership(Rent/Mortgage/Own)
This seems irrelevant. “Own” indicates that the borrowers has equity in the house that the collection agency can go after should he/she go into default. “Mortgage” may suggest that the borrower has “some” equity in the house, which can be good. But he/she could easily have an upside-down mortgage, which is very common these few years. “Rent” could mean a little more financial freedom ironically, but there’s no real estate equity to go after if the borrower defaults.
Revolving Balance Utilization
This seems irrelevant to the ability of the borrower to repay the loan.
Interest Rate
I invest across different interest rates to assemble a balanced portfolio. But for those that want to invest only in certain interest rates, this filter can be useful.
Term
The only 2 terms possible are 36 months or 60 months. I invest in either categories. For 60-months loans, they offer a better interest rate, so you can maximize your return with them. For 36-months loans, your money gets tied up for a shorter time.
Credit Score
I also invest across different credit scores. The scores may or may not be a good indicator that the borrower will default.
Interesting Scenarios
High Revolving Credit Balance but Borrowing for Vacation
If I was deeply in debt for like $30K, I would make sure I stay in town and not spend any unnecessary money until I pay it all off. Let alone borrowing extra money to take a vacation. I’ve seen people who are doing that. And I have no sympathy for them.
Debt Consolidation Loans with a Much Lower Revolving Credit Balance
Sometimes you see people borrowing a much higher amount of money in a Debt Consolidation loan than what he/she currently owes in the revolving credit balance. This usually would get me thinking. However, I was told that this can easily be spousal debt.
Business Loans
I don’t lend to business loans for the simple reason that there is more uncertainty in a small business than a regular person. For a normal person who gets a paycheck, you can evaluate the person by many factors including the credit report, income information, etc. As a business though, there’s no additional information provided to you about the business. This exposes you to more risks. And what’s worse is that you won’t know about it.
Medical Expenses
Medical Expenses loans also expose you to more uncertainty as nothing about the person’s medical problem is verified.
Final words
Make your own judgment (or just let them automate it)
On Lendingclub, you’re presented with information that’ll help you decide which applicants are worth your money investments. The information, regardless of how useful it is, is partial and may never tell the whole story about a particular borrower’s situation. It is then up to you to make your judgment based on how comfortable you feel using that limited information.
Some borrowers will default
At the end of the day, some borrowers will eventually default, no matter how rosy the borrower painted the picture in the application. And you’ll have no control over that. In a way, it sorta breaks the purpose for Lendingclub to just disclose all the information it’s got about the loan applicants. First, there are privacy concerns. And most of all, for Lendingclub to be successful, it has to be easy enough to use for average Joes.
Use the limited information wisely towards achieving your desired return on investments. That’s all there is to it.