Awhile back, I started playing with Lending Club, a site where you can invest small amounts of money (as little as $25) in people who have applied for personal loans.
Before we go on, let me give you the disclaimer: I’m not a financial pro and these views are mine alone as an average person like you trying to maximize my dough. Returns are not guaranteed and your experience may be different.
What You’ll Learn
- The pros of Lending Club
- How Lending Club’s loan system works
- The most common types of loans to invest in and how to find categories you prefer
- How I diversify and still keep proper allocation weighting to minimize risk
- How to find loans that maximize your return and stay as safe as possible
I’ve been playing with Lending Club since April 2011 and I like where it’s going. Until recently, I was averaging a 13% return annual return. Just this week though it’s down to 8.24%. I’ll explain why that happened. But either way, it’s still beats the crap out of those piddly CDs.
Here’s what’s good about Lending Club right off the bat:
– You can save little bits of money at a time. For people who have trouble putting anything away, it’s a good way to get some discipline.
– Loans are double vetted by the company and that really lowers the risk a lot.
Let’s dig into the Lending Club system and see how it works:
1. People who need a loan for whatever reason apply to Lending Club and are vetted by the company before the loan is opened up to the public.
2. Each loan is given a rating from A to G based on a variety of factors including the applicant’s credit score, monthly income, current debt, delinquencies, etc. A loans are the safest and therefore net you the lowest percentage rates. G loans are the most risky and have the highest rates.
3. As a lender, you deposit some money into your account and browse the loans to find one you like. I’ll give you my strategy below.
4. When you find a loan you like, you invest as little as $25 and complete the order.
5. Once the loan is fully funded by however many people it takes to get it filled, it then goes through a second review process before it’s actually funded. If the loan applicant doesn’t pass this second review, your money pops back into your account and is available to invest with someone else.
6. If the loan is approved, they recipient makes monthly payments just like a bank loan. Each month you get a portion of the principle plus interest.
7. As your money plus interest comes in, you can reinvest is in more loans or pull it back out.
It’s pretty darn simple and one of the lowest risk investment vehicles I’ve run across in awhile. I wouldn’t recommend it as the bedrock of your investment system, but it’s a good place to stash some extra money and let it grow. You can even open IRAs with them and invest that way.
It’s not risk free, of course. As I mentioned, I was getting 13% for the last couple years until just this week. One of the loans I was invested in went delinquent and was charged off. So I lose that $25. However, I’ve certainly spent $25 on dumber things. As of this writing, I have $440 spread over 24 loans in my Lending Club account, so it’s not a huge hit by any means.
A huge majority of the loans are for credit consolidation. 78% according to the stats on LC’s site. But you can also run search filters that let you find loans you’re interested in like small business loans or only people that want to buy boats. I will often go with a small business loan over the credit consolidation if the numbers are close just because I like to invest in people with a positive and proactive life plan rather than someone who screwed up and is digging themselves out. Pros and cons to both of course. And like I said, most of the loans are people digging out of a credit mess.
And every time I log in, I find it supremely ironic that I’m investing in loans for people that make 3 times as much money as I do. Just goes to show that making a lot of money doesn’t mean you know how to handle it.
Ok, so here’s my Lending Club strategy for picking loans:
1. I try to keep things pretty weighted towards the risk-free end of the scale (A and B loans) with a smattering of risky loans to get my ROI up. Diversity is the name of the game here, but the weighting has helped me a lot.
The one loan that recently charged off was a D loan that was paying 19.22% interest. My current allocation looks like this:
A Loans – 6
B Loans – 7
C Loans – 6
D Loans – 5
E Loans – 1
Right now it’s not weighted like I’d like. My next couple purchases will be A’s and B’s to get thing to a more 3-to-2 ratio of safe (A/B) loans to risky (C/D) loans. And as you can see I keep the extra risky stuff (E) much smaller in the weighting. More of a 5-to-1 weighting on those.
Why no F and G loans? I don’t have enough diversity yet to dip into the F loans, though they offer the best return according to Lending Club stats. 14.07% on average. But I want to have that be about a 10-to-1 ratio in my weighting.
G loans only get and average of 12.25% return, which is less than D loans. So it doesn’t make sense to take on the extra risk without the extra return on those.
Let’s say, I’m looking for an A loan. I’ll go to the “browse notes” section. Then I’ll filter by 36 month loans and A rated loans. You can also do 60 month loans. But I read in someone else’s post months ago that he didn’t think the additional rate of return was worth tying the money up for an extra two years. In fact, you can often find the same rate on a 36 month as you would have gotten for a 60 month anyway.
Once you got your filtered results, click the rate column header to sort by interest rate. You may have to do it twice to get the highest rate sorted to the top instead of bottom. Once I know what the going highest rate is, I’ll click the credit score column header and sort by credit score.
At this point you’ll be able to pick out the loan with the highest interest rate and highest credit score. From there I’ll start looking at which of those loans are already nearly funded, for two reasons. If a loan is already nearly funded that means a lot of other people think it’s a good deal too. Plus, there’s a better chance the loan will get through the second review process and actually be funded.
This is also where you can go with some personal preferences and intuition. In looking at the details of the loan you’ll see things like how much revolving debt the person is carrying, when and if they had delinquent payments, what their monthly payment will be, often their household expenses. So you can get a more detailed picture of the applicant and their financial situation.
Because the letter scores take all that into account, you won’t usually find many surprises in there. But it gives you a little personal connection with the person and you may find one you click better with intuitively than others.
Once you find a loan you like, you just click the little check box, click add to order, and then complete the simple order process. If for some reason the loan isn’t funded, you’ll get an email that your money and been put back in your available account and you can find something else.
That second vetting process much be a real bear because the loans I pick get kicked back about 40% of the time. I like that that happens because it means Lending Club is really looking closely at these loans and watching the backs of their investors. In fact according to their stats, since 2007 they’ve funded a bit over 114,000 loans and declined over 845,000. So they’re not handing out your money all willy-nilly.
Peer to peer lending is becoming a big thing, which means other sites and companies are popping up. Prosper.com is another sizable one. Lending Club seems to be largest though. Plus their offices are 30 minutes from me. So if things go really wrong, at least I know where to find them. 😉
There are also peer to peer lending sites like Kiva that let you invest in small businesses around the world from a more charitable angle. There’s no return on these loans except your principle and the good feeling you get from helping someone get their feet under them. But some charity stuff should always be part of your financial mix as well. Both for the tax write-offs and so you don’t have asshole Karma.
I’m currently invested in 33 loans with one being overdue in the 31-120 day range. So good chance that will be a charge off like the one other that has been. It’s been partially paid, so I’ll only be losing $16 on that one. 8 previous loans have been paid in full.
My annual return (adjusted for the one overdue loan) is 9.26%. Up a little bit from previously. I may try out one of those F-grade loans to see if I can bump that back over 10%.
So that’s the way I’m stashing some money away and making it grow between 8 and 12% with Lending Club. Do you have a killer Lending Club strategy? Or questions? Drop a comment below and let’s discuss. 🙂