With the latest decline in the stock market, I've been looking for other places to invest money. One types of investment that I've always been interested in is Lending Club (other site exists such as Prosper). The basic concept is micro-lending to other investors in a peer-to-peer fashion. I can be a small bank making small loans (along with many other investors) to borrowers.
Before I dig into the details, I'll do a quick bullet point overview of what Lending Club. You'll want to visit Lending Club's site to get the full details.
- Borrowers need to to find cash.
- Investors want to invest cash.
- Lending Club is the intermediary to bridge borrowers with investors in a peer-to-peer fashion.
- Depending on the borrowers credit worthiness, loans are offered at various interest rates ranging for 5.32% to 28.99%.
- A borrower's loan is split into increments of $25 for investors.
With that, I had several questions as a Lending Club investor:
What kind of borrower would want such a high interest rate?
I often consider myself money conscious. I would never consider buying consumer good or go on vacation if it means debt. I would never put a purchase on a credit card without knowing I had the cash to pay off the credit card at the end of the cycle. So who are these borrowers who are willing to accept such high interest rates? After talking around, I found that Lending Club borrowers are probably in tough situations and may need cash, but the bank is unwilling to loan them money (in a way, this is how the traditional credit unions started). Borrowers who may have high credit card rates can lower their payments with a lower rate through Lending Club.
How are Lending Club Borrower's Details Vetted?
According to users who have gone through the borrowing process, the process of approving a borrower takes only a couple of minutes. My guess is that Lending Club runs a credit check on you to determine certain information such as how often you were delinquent. After the account has been fully funded, When your loan is fully funded (via peer to peer funding), Lending Club requests more information. Three pay stubs, tax stubs, verification of your bank account, and then a credit history check. My biggest surprise is that Lending Club only requests additional information after the loan has been fully funded.
What happens if a Note is Late?
Because Lending Club only offers investors unsecured loans, this means that if a loan were to become late and default, you lose the money (similar to what would happen with a bank). Lending Club does it's best with in-house and 3rd party collection agencies. There is a lot of regulation in the field of collection and investors will not be allowed to contact the investor. I suggest carefully reading over the Lending Club Statistics. There's a lot of good information.
What happens if a borrower turns out to be a scam artist and I invest in a bad loan?
Isn't it easy for a borrow to come along to put in fake details to get a large sum of money, and not pay the monthly fee? After all, these are unsecured loans? The answer is yes, it it does happen, as seen here. But the statistics take that into account and this is a reason why you should spread your money out over many investors using the smallest increment of $25.
Lending Club has been around long enough where I'm no longer worried about Lending Club as a company going out of business (yes this was once a big concern for many investors). Their system provides a great deal of transparency and my belief is that if I diversify my notes enough, I can be protect against scam loans and still make a solid return. I'd be happy with 8% return, but this will take awhile to realize the gains (as I'll need to make back my principal.
I like the highly transparent estimated yield based on historical data, plus the ability to filter down loans based on borrower information. This allows me to invest in loans where I believe the borrowers have the highest chance of returning my money.
Here are my requirements for trustworthy loans:
- Delinquencies (Last 2 Years): 0 (lowest)
A borrowers who has had many delinquencies is more likely (in my opinion) to default again. They may not have the right money management skills.
- Min Length of Employment: 5 years (highest)
I prefer a borrower who has a stead stream of income. Someone who is jumping from job to job may hit a rough patch causing the loan to be late.
- Months since last delinquency: 60 months or more (highest)
Similar to a previous filter, this one tells me that even if someone has had a delinquency after 2 years, that it was at least 5 years ago. This gives me higher confidence that the borrower has learned his mistakes.
- Exclude Loans Already Invested: Yes
Having this checked means i won't accidentally invest in the same loan twice. It's good practice to diversify by holdings.
Once this has been filtered, I'll also often look at:
- Job Title
A borrower with an unofficial or unstable job position scares me. Surprisingly, I've seen n/a on this field from time to time.
- Home Ownership
I prefer borrowers who Own or have Mortgages as opposed to renters. In my opinion, a borrower who is able to own/mortgage has been previously vetted by a bank with a loan, and that to me is a bonus.
- Loan Purpose
I prefer a borrower who is Loan Refinance & Reconsolidating, Credit Card Payoff, or Home Improvement Project. Many of the other options, though reasonable, isn't a reason I'd invest money.
Finally, I've invested my loans and they are slowly being issued. My first 200 notes will go into a portfolio to track its success. As I begin to profit and receive money, I plan on re-investing the gains into additional notes.