Updated: July 20, 2012
Lending Club Review - Low Risk Investments, Steady Returns
-- "How to grow your savings nearly 10 times faster than the average investor."
Lending Club is one of the best peer lending companies. Founded in 2007, this San Francisco, California based company has succeeded in redefining the peer lending industry with around half a billion dollars in loans and roughly 10% of that - 50 million dollars - in interest paid to investors. The company has won several honors and awards since its inception, the most recent being Forbes America's Most Promising Companies, 2011. I have been investing with the company since early 2009 and this Lending Club review is primarily based on my personal experiences as an investor, although I will cover a bit of the borrower aspect too. Before investing, I researched the borrower part too because in order to succeed as a person who advances loans via the peer lender, I needed to know how the company selected their borrowers. I'm extremely happy with Lending Club so far, since my investments with them have netted me between 10-12% APY over the past three years, which is more than 10 times the returns from my ING Direct Electric Orange account that yields less than 1% APY.
Last tax season, I have also invested some funds in a Lending Club No-Fee IRA with the goal of growing a part of my retirement money steadily and tax-free.
What is Peer Lending?
Simply put, peer lending means one person lending to another. Most of us would've lent or borrowed some money to or from friends and family at some point of time. Lending Club provides a solid platform for peer lending that's not available from a traditional or online bank. They are far from being just a middleman between the investor and the borrower. For example, their stats show that 90% of all loan applications get rejected after initial scrutiny, since they have really strict criteria for borrowers. Although at first it may look a bit discouraging to a borrower, the increased loan evaluation is in the best interest of both investors and borrowers. Serious borrowers would get their loans funded because of less competition, and investors would benefit from less defaults.
What are the features that separate Lending Club from other peer lending companies?
Let's take a look at some of the key distinguishing factors of Lending Club in this review.
- High Interest: The company pays me 10-12% APY in interest, which is way better than any brick and mortar or online bank. Coupled with high security, I consider Lending Club investment as a Savings Account with 10x the average interest.
- High Security: Lending Club approves only highly qualified borrowers. Their stats show that the average borrower has a 700+ FICO score, less than 15% debt-to-income ratio, 10-15 years of credit history, around $70K in verified annual income and average loan size of $11K. It's pretty evident from these stats that such borrowers are ideal for anyone interested in peer lending, as they are less likely to default on their loans.
- Better Risk Reward Choices: The peer lender provides a wide array of loans based on your risk tolerance. The loans are rated A1 through G5 grades, with A1 being the safest but lowest rates and G5 has highest rates with highest risk. If you are young, you could dabble a bit more in high risk-reward loans since you have more time to make up for any defaults.
- The ability to withdraw funds at any time by selling your investments (called Notes) to other investors via the FolioFN platform. Your money is not tied up as in Bank CDs. In financial terms, this is called increased liquidity for your funds.
- Statistics: Their platform provides tons of statistics on potential investment returns, likelihood of defaults, other investors' average earnings, and a whole lot more. These stats help me make informed decisions on which loans to fund.
- Email Alerts: Lending Club sends emails alerting me of sleeping money in my account that's not earning interest. These are funds that get credited to the account each month as repayments of loans by borrowers. These alerts help me invest in loans faster and earn more interest.
- Automatic deduction of repayments from borrowers' bank account every month. This further reduces the chance that a borrower misses a payment.
- The ability to communicate with the borrower. You can send questions to the borrower of a loan that you are interested in funding, if the description is not clear. Your privacy is guaranteed. All the borrower will see is your screen name.
How to become a lender through Lending Club?
The process is quite simple:
- First, Open an Account at Lending Club and transfer some funds to the account. You can start with as little as $25.
- Invest your funds in what peer lender calls: Prime Consumer Notes. Each Note has a face value of $25 and represents one unit of a specific loan by a borrower. You can invest in as little as one Note in any loan, which means that the minimum amount that you can invest in a loan is $25. I will use both terms - Note and loan - in this review. Just remember: 1 Note = $25 of a loan.
- Watch the cash roll in every month into your account. When your borrowers repay their loans, the principal and interest get automatically credited to your account every month. You may choose to withdraw that money or re-invest in new Notes - your choice.
How to choose the loans to fund, which Prime Consumer Notes to invest at Lending Club?
Lending Club offers Notes from Grade A1 to Grade G5. A1 Notes are for loans by borrowers that have high credit score, lowest debt-to-income ratio, etc. So, these loans are at the least risk of defaults, but offers lower interest rates. G5 Notes are of higher risk, and offer higher interest rates. Like any other type of investments, I prefer to split my funds into a variety of Notes. I do not invest in a loan just because it is Grade A1. Also, I don't turn away from one just because it's a C3. Although, I must say that I have never found a good loan below C3 Grade that meet my criteria.
Here are the 10 strict criteria that I stick to when picking loans, that is, when investing in Prime Consumer Notes at Lending Club. These criteria have helped me earn 10-12% APY since 2009.
- Credit History of at least 5 years. This would generally rule out folks that are just out of school or those that just migrated to the US. No offense, but based on my research I have found that borrowers with less than 5 years of credit history are more likely to default.
- 725+ Credit Score. FICO has already implemented a good framework for ranking individuals based on various financial factors. Roughly 50% of US population fall below the 724 credit score mark. So, pretty much I'm going with the top half of borrowers.
- Debt-to-income ratio of 20% or below. This would rule out those borrowers that have too much debt that are more likely to default.
- Selective Debt Consolidation. You will find that debt consolidation loans are one of the most popular categories at Lending Club. It makes sense for people with high interest debt, like credit cards that charge 25% interest, to consolidate their debt with a Lending Club loan at half the rate. I'm selective here - I would consider only A grade Notes for such loans. I look for signs of someone who suddenly had a wave of expenses that put him/her in short term debt. Since these are A notes, it implies they are very good borrowers that have already been paying off higher interest rate debt (like credit cards) and are financially savvy enough to turn to the peer lender to reduce their interest and consolidate debt. Such borrowers have a low chance of default even for debt consolidation loans.
- Verified income of at least $75K. These borrowers represent the top 10% of US population based on income. Again, less chance of default.
- 3 as well as 5 year loan terms. Lending Club did a good job limiting the minimum period of loans to 3 years, otherwise the monthly payments would be high for the borrowers, leading to higher defaults. I pick a mix of 3 and 5 year loans because a 3 year loan gives me the advantage of getting my money back quicker whereas a 5 year loan has the advantage of steady monthly income over a longer term. I tend to pick 3 year loans for smaller loan amounts and 5 year loans for larger amounts. With this strategy, the monthly payments of borrowers would fall in the affordable range, so the risk of defaults is less.
- Always invest in multiple loans. I never invest more than 10-15% of my funds in any one loan. The best option is to invest in just one or two Notes per loan, but then you would need to keep track of a lot of loans, especially if you are investing large amounts in your account. Not a big deal because Lending Club's platform makes it real easy to keep track of loan performances.
- Lower amounts in higher risk loans. I invest most of my funds in Grade A loans, lesser in B and even lesser in C. In Grade A loans, I tend to invest more Notes per loan, lesser Notes per loan in B and even lesser in C. I have invested in as many as 5 Notes in some Grade A loans. Each Note is $25, so that's $125 in one loan. For Grade B loans, I invest in not more than 3 Notes per loan. I never invest in more than 1 Note per Grade C loan. The reason for doing this - Grade A loans have less risk of default than B or C. So, the higher the risk, the lower is my investment per loan. This would spread the risk-reward evenly across the loans. You would agree that this is a common sense approach to any kind of investments, not just Lending Club Notes.
- Diversification. I hold only around 10% of my total investments in Lending Club. The rest are spread out in other types of investments. Prudent investors should never put all or most of their eggs in one basket.
- Emotion-free investments. You should never invest in a loan just because the borrower tries to win your sympathy. It's your hard-earned money, so keep your antennae up when reading a loan description.
Hope you find these tips useful for your investments with Lending Club. Go here to earn around 10% interest when you open an account with Lending Club.
You may also wish to check out their No-Fee IRA while you are there. Earning a steady 10-12% APY tax-free is no small thing in this economy.