Steadfast FinancesMy Plan to Beat the Lending Club, Peer-to-Peer Investing Average

My Plan to Beat the Lending Club, Peer-to-Peer Investing Average

Filed in Investing 101 , Peer to Peer Lending 62 comments

~ ~ ~ April 2011 Update: Shutting Down My Lending Club Investments over Q&A Change ~ ~ ~

~ ~ ~ December 2010 Update: Earning 15.6% NAR on Lending Club investment portfolio ~ ~ ~

lending-club-shaking-hands-over-a-loan-or-promissory-note

Growing up, most kids I knew wanted to be an astronaut or play in the NFL. Always being one to go against the flow, as well as being a killer Monopoly player, I always wanted to be a banker.

I’m aware it’s an odd admission, but for some reason, the idea of using money as a means of making more money always seemed to appeal to me. When most people think about making money (at least in my experience), they think about starting their own small business or maybe making widgets out of their garage in their spare time. Not me. I always wanted to be a landlord and/or loan people money.

Over the years, I’ve made a few financial moves to make that happen (e.g. owned a rental property, became an active investor, etc), but there really wasn’t a viable (or legal) way for the Everyday Joe to receive the same ROI as traditional lending institutions like Bank of America or JP Morgan. Until now!

I’ve been flirting with the idea of Peer-to-Peer Lending for a while now, but due to the recession, I held off for fear of having too many loans go into default and lose a substantial percentage of my capital. After watching Beat the Average (a webinar with Scott Langmack of PeerLendingWealth.com and Patrick Gannon of Lending Club), I decided to push ahead and slowly begin investing in a small number of P2P loans since only 4% of prime borrowers (credit score >650) defaulted on their loans during the 2008-2009 recession.

Beating Lending Club’s Average Return of 9.6%

Being the novice P2P investor, I realize I could be setting myself up for a huge disappointment here. However, I’ve put some serious thought and time into this plan, so I’m fairly confident I’ve put together a strategy to get double digit returns or more. Hopefully, I’ll hit the 12% to 13% ROI mark.

Here’s my plan:

  1. Diversification. I’m investing no more than $25 per loan. The more notes you buy, the more you are reducing your risk of loan defaults. The same basic principle in index fund investing applies here: the more diversified you become, the lower the risk of one (or a small few) bad apples spoiling the bunch.
  2. Loan Purpose. Obviously, a borrower has to have a viable reason for requesting a loan. If the borrower wants to improve their home, refinance existing debt, or consolidate a few outstanding loans, then they are viable candidates. If they are applying for a loan because they can’t get financing elsewhere or they want to “jump on a new business opportunity”, then I will have to pass. Since this is my money, I want to loan it to someone who has an extremely good chance of paying it back with interest.
  3. Credit Score above 679. Lending Club gives you the ability to search for borrowers within a wide range of above average FICO scores. The current system of credit scoring might not be the best indicator of an individuals ability to repay a loan, but for now, it’s the best metric available and has many years of backtesting to support its validity. I’ll be lending to borrowers with a FICO score as low as 679, but will be giving preference to borrowers with a 720 and above.
  4. Job Security. I’m giving preference to government employees (state or federal) and seasoned professionals who have been in their current profession for more than five years. Since we’re still in a recession, and job losses are floating around the 10% mark, lending money to job hoppers or new college grads with lots of student loan debt seems like an unnecessary risk at this time.
  5. Past Delinquencies. Since the goal of investing in P2P notes is to get repaid every month, I’m only going to lend to borrowers who pay their bills. That means I’m excluding anyone who has had a past delinquency in the last three years. Perhaps an exception can be made to a borrower with an exceptional credit score who had a reasonable excuse (e.g. computer glitch, banking error, etc) for one delinquency, but no more than one.
  6. Debt to Income (DTI) Ratio. Preference will be given to borrowers with as low of a Debt to Income Ratio as possible. Lending Club gives you the option of searching for borrowers with varying DTIs, but I will likely give preference to borrowers with a DTI < 20%. The better the borrower’s monthly cash flow, the lower the risk of default.
  7. Loan Amount. Obviously, the monthly payments for a $5,000 loan are easier to repay than a $20,000 loan. When given the choice between buying two notes of equal credit worthiness, I would choose the borrower with the lower loan amount.
  8. Revolving Credit & Revolving Credit Line Utilization. I don’t get a warm and fuzzy feeling lending money to someone who has maxed out, or nearly maxed out, their existing lines of credit. Perhaps if a borrower wants to refinance their current credit card debt to a lower Lending Club interest rate (which is a smart move considering some creditors boosted their rates on prime borrowers), or consolidate multiple outstanding balances into one lower monthly payment, then I might consider them a viable candidate.
  9. Attention to Detail. If the borrower has more than one typo or consistently uses poor grammar throughout their application, I’m likely going to look elsewhere. We’re all human, and even the best of us make mistakes when it comes to writing an electronic document, but a loan application should not be one of those times. It is their one and only chance to show they are a creditworthy borrower. Period. If they can’t fill out a loan request accurately and put their best foot forward, there are plenty other borrowers who will. And those will get my business.
  10. Questions & Answers section. Since investors have the option to ask the borrower specific questions, their responses are probably the best chance within the Lending Club system to peek into the mind of the borrower. The web may be a cold and impersonal compared to the traditional image of shaking a man’s hand prior to giving him a loan, but it is still no reason to brush off a question or answer questions in a snide, jester like tone. I’ve already passed on several loans where the borrower seemed to have a poor attitude, answered rudely, or failed to adequately answer the posed questions.

Again, this may not be the best way to invest in P2P loans with Lending Club, or for that matter, with Prosper.com (Lending Club’s prime competitor). This list is just my own personal method of selecting and weeding out the best possible loans with a higher rate of return and, hopefully, a lower risk of default.

How about you? Are you a Lending Club investor? Have you implemented a strategy similar to this? Would you do something completely different or only modify one or two specific line items in this list? Please share in the comments section below.

Quarterly Lending Club Investment Portfolio Updates

April 2011 Update: Shutting Down My Lending Club Investments over Q&A Change

December 2010 Update: Currently earning 15.6% NAR on Lending Club investment portfolio.

September 2010 Update: Currently earning 15% ROI on my Lending Club investment portfolio.

June 2010 Update: Currently earning 14.2% ROI on my Lending Club investment portfolio.

March 2010 Update: Currently earning 13.6% ROI on my Lending Club investment portfolio.

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Posted by CJ   @   1 September 2009 62 comments
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62 Comments

Comments
Apr 15, 2010
3:34 pm
#1 Holly :

Why do financial aid sites such as:

http://www.studentloansforcollege.org/peertopeerstudentloans.html

suggest that these types of loans are easier for the borrower to get than a private student loan, are the borrowers not credit checked, do investors have any say in who they get to borrow to on most of these sites?

Apr 15, 2010
8:00 pm
#2 Matt SF :

Holly,

First, I really wouldn’t trust the info on a site/blog like that. It’s got very little content, covered in ads, and doesn’t offer the ability to comment. Usually not the best place to find reliable, quality articles about important financial topics.

But in regards to P2P loans being used as student loans, I’m quite sure they are not the best way to get the funds you may or may not need.

In fact, I would almost guarantee, unless you have superior credit (750+ FICO, low Debt to Income, haven’t missed a payment in 60 months, etc.), that you can get a better student loan interest rate from a Federal student loan program like Stafford loans or Parental Plus loans.

P2P loans are great when you can’t get traditional financing or have an aversion to traditional banking, but often times, you’ll pay a slightly higher interest rate. This is because P2P loans are usually unsecured loans, which means that lenders (e.g. P2P investors like me) can’t seize your car, foreclosure on your house, or seize whatever asset you used as collateral.

On the flip side of this, many borrowers are using P2P loans to refinance their high interest credit card debt or debt consolidation loans because 6% to 20% (Grade A to Grade E) sounds better than paying 29.99%.

To answer your specific questions:

Yes, the borrower’s credit is checked and investors have access to that information. It’s anonymous, so we can’t see your name, address or contact information, but we can see your income, credit history, employer, etc. Based on each investors goals (conservative, balanced or ultra risky), we can select from a fairly large array of loan applications. As you can see above, my standards are pretty tight, but my Lending Club average return is around 13% thus far.

Yes, the P2P Lending company has the right to accept or reject any loan application they wish. For example, Lending Club cuts you off at a credit score of 660. If your credit score is less than 660, they won’t even upload your loan application for funding. Furthermore, some loans may not receive enough interest to be completely funded because they’re too risky, the borrower didn’t answer investor questions, or something just didn’t sit right with investors.

So just because your loan app got listed, you may not get fully funded. In that respect, it’s just like meeting with a banker sitting behind a desk. Just because you get a meeting, it doesn’t mean he/she will approve your loan.

Sorry for the long answer, but you asked some really good questions.

Jun 29, 2010
8:32 am
#3 keith :

my big question is: is this a fad and will in say 5-10 years go *poof*? pertuity direct just up and left without notice

Jun 29, 2010
8:55 am
#4 Matt SF :

That’s a fair question considering the P2P Lending/microfinance marketplace is getting more competitive. So the first to market (Lending Club and Prosper in US, Zopa in UK) are going to crowd out the weaker, lesser known brands.

I don’t think P2P Lending will be a fad because I don’t think debt will go out of style. We live in a consumer based nation where advertising is highly persuasive, so the probability that we’ll become a nation of savers versus spenders is pretty low. As long as the big banks don’t offer a “consumer debt mutual fund” where they offer us 9% ROI on our money, I’d say it’s full speed ahead.

I would prefer we saved more and consumed less as a nation, but then again, Lending Club would lose around 60% of it’s loan applicants since many of them currently in the database are looking for fixed rate loan for debt consolidation (mainly credit cards with 20%+ interest rates).

Aug 6, 2010
12:47 am
#5 Roche :

The only thing that is going to go “Poof” is Prosper – And it will take them less then 5 years to do it.

Aug 4, 2010
8:09 pm
#6 Penny :

Good post! I have been playing with Lending Club also. So far I’ve only invested the $25 they’ve given me for signing up. But it has been a positive experience.

My note is getting 14.70% interest with no missed payments. With some planning, and diversification I think this may be a feasible alternative investment means.

I’ll take your notes into consideration when I pursue this idea further! : )

Thanks, Tabz.

Aug 4, 2010
8:25 pm
#7 Matt SF :

Thanks! I’m happy with Lending Club thus far. Got around $3500 there earning 14.5% NAR with no defaults (at $25/note).

A few LC investors and I send out a weekly email discussing the notes we like. If you like, I can CC you on the next round.

Dec 1, 2010
2:14 am
#8 Chris :

I have been trying both Prosper and LC for the last 3 months, each with $100 and both are returning about 19% thus far. I am thinking of adding another $1500 to LC, though the rates are lower, I think it would be more stable. Any chance I can get on your next email?

Dec 1, 2010
8:53 am
#9 Matt SF :

19% is VERY respectable Chris. Most people believe that a 15%+ return isn’t really possible over time, but if you have the ability to slowly add in your money and cherry pick those high yield notes that you believe will have the lowest rate of default, it would appear that is indeed achievable.

I’ll include you into the list today.

Aug 5, 2010
2:36 pm
#10 Melissa :

I started in January of 2010 & have 32 loans (none over $100) with LC @ 16+ % — so I’m on the risky side. I figured I’d try risky first to see what the worst case scenario is for microlending. I tend toward debt consolidation loans – but for ppl with relatively high credit scores. I read the Q & A carefully to see if the borrowers get it that they are borrowing from real human beings. The ONLY loans that have posted late payments are from the two people who BOTH work in the financial industry. Incidentally, I had put their loans in my portfolio labeled “Riskiest” upon my investment in them. Boy, I was right.
MattSF, if I may be so bold, I’d be interested in being included in your email list.

Aug 7, 2010
4:47 pm
#11 Matt SF :

You got it. Sending one out early next week.

Nov 5, 2010
7:13 pm
#12 Josh :

I’d also like to be added to the weekly email list if possible. thanks so much for this very informative post.

Aug 6, 2010
1:38 am
#13 Roche :

If you limit yourself to just $25 per loan then you can only take limited advantage of what your criteria tells you to be a loan worthy of your investment dollars. On some of the loans try investing two to four percent of the amount borrowed. I would avoid the loans where the monthly payment is more then about $215 dollars. One thing that really annoys me on Lending Club is borrowers who don’t fill out the Loan Description. If someone wants to borrow money they should give their benefactors a paragraph on what the loan is for and another paragraph on themselves. I would be interested to know how much of your Lending Club investment capital goes to buying notes off the Folio trading platform.

Aug 7, 2010
4:50 pm
#14 Matt SF :

I’m of the mindset that the more loans I have, the more diversified I am, which would imply the less probability of a loan defaulting. Lending Club seems to back up this idea.

However, I certainly acknowledge that adding $50 or $100 to a single note might be a solid idea if it pays off, but with today’s job market and rampant layoffs, I’d rather go the diversified route.

Aug 6, 2010
1:41 am
#15 Roche :

A creative way to encourage the people to whom you are lending to pay back their loan is to ask them if they have read “Total Money Makeover” by Dave Ramsey. Of course Mr. Ramsey does not advocate individuals borrowing money in the first place but if an individual is in the “second place” where they have already borrowed money (or are in the process of doing so) then this may provide them with a source of inspiration to pay their loan off (or cancel their loan request altogether). Certainly on any loan requests for “Debt Consolidation” this should be a mandatory question that you ask before investing a single dollar in such a loan. A person can strategize all they want in order to decide which loans to fund and how much but in the end who knows if that roulette ball called “your $X note” is going to land in the green zero slot called “default”. Place your bets and Good Luck.

Oct 23, 2011
4:56 am
#16 Xin He :

The December 2010 update link at the top directs to this post http://steadfastfinances.com/blog/2010/09/21/lending-club-update-earning-15-nar-on-microloan-investments/ which is not the right post.

Oct 23, 2011
10:44 am
#17 Matt SF :

Fixed. Thanks for spotting this.

Nov 15, 2011
12:32 pm
#18 Craig B :

Matt, I have two LC accounts, one regular and one IRA. I’m currently getting 9.2% and 13.7% respectively. I’ve had a few defaults, but that’s expected (and reflected in their stats). I just have a few comments on your strategy. First, I don’t think it makes sense to limit loans to those with lower payments. To me, what is more important is the ratio of the payment to their salary (especially if they’ve answered questions about their monthly expenses). I try to limit my loans to those where the monthly payment is less than or at least close to 10% of the applicant’s salary.

I used to limit loans to applicants whose salaries have been verified by LC, but LC tells me that statistically unverified incomes are marginally safer. They will often verify income because there is something fishy in an application.

I also don’t think it makes sense to limit yourself to lower loan amounts. In my experience, people who are desperate for $5,000 or $10,000 are living closer to the line and have fewer resources to fall back on should they lose a job or suffer a personal setback. This is born out by their lending statistics. The bigger the loan, the higher the rate of return.

Nov 20, 2011
4:27 pm
#19 Lucas :

The impression I am getting is that the A-rated loans are less attractive because of the lower interest being paid.
In fact, somewhere in this blog I read a comment stating that the writer passed on an other stellarloan application because the interest rate was “only 5.7%” (if memory serves) and not worth it to him. That’s a shame for borrowers who have been financially responsible enough to earn the A-rating.

Part of the reason to participate in P2P is to create a community outside of the usual profit-first mentality and help each other.

For example, I am looking at fixer-uppers because it requires twice the median income in my town to purchase a median turn-key house. The thing with fixer-uppers is that bank often won’t lend on them, and hard money lenders want usurious interest. I certainly hope that when the time comes, my stellar loan application will be fully funded despite its low interest relative to other LC loans.

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