~ ~ ~ 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 ~ ~ ~
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:
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.