LendingClub, Good or Bad for Investors?

Lending Club ReturnsUpdate 10/20/16: Since originally posting this article LendingClub has come under a scandal, but I don’t think that had any effect on returns.  What I have noticed is that the returns are decreasing due to more defaults.  So at this time I would say it is even riskier than I stated previously and would recommend people to stay away.  However, you are free to make your own decisions and hear what brought me to LendingClub in the first place.  If you end up deciding to invest, I have provided links so you can get a hefty bonus.

Saving your money is great, but it is even better if you can have that money work for you so you get to experience compound growth. The simplest of ways to get compounding is through an interest-bearing savings account or certificate of deposit (CD). However the yields on these are 2% or less, so after 10 years you would grow $1,000 to $1,219, not bad for doing nothing. However, if you invested that money in an investment with a 7% yield, you’d have $1,967. The longer the duration the larger the growth will be. Now that you can see the desire to grow your money let me explain one investment that I believe will get me a 7% yield and if I’m lucky maybe even more.

The basics

The investment I am talking about is peer-to-peer lending.  This is where you invest money in loans taken out by normal people.  Instead of giving them the whole loan amount, you can lend them just a fraction as low as $25.  The loans are often for people who are riskier than average and therefore have to use peer-to-peer to find an unsecured lending option.  The two main platforms at the moment are LendingClub and Prosper.  I used LendingClub, so I will write about my experience with that.

Requirements

You can invest if you live in any state aside from Alaska, Maryland, New Mexico, Ohio, and Pennsylvania. You must have an annual gross income of at least $70,000 and a net worth of at least $70,000 or a net worth of $250,000. For Californians the numbers are $85,000 income and net worth or $200,000 net worth. Finally, you agree not to purchase more than 10% of your net worth. This is a risky investment, so they are trying to protect you from losing a bunch of money should things go poorly.

Diversify

You have probably been told to diversify your portfolio because you do not want to hold all your eggs in one basket. When Enron failed, many people lost their life savings because all their money was in that company. Similarly, LendingClub is a platform where you can and should diversify your holdings. If you invest $2,500 you can buy up to 100 notes and I would recommend that. The minimum investment in a note is $25 and the maximum is the value of the note. Would you rather loan 100 risky friends $25 each or one person $2,500? Since you are not doing the collecting, it is best to spread your funds out because one person could easily default, maybe even ten, but probably not 20 or 50. There are no guarantees, but it definitely safer to diversify.

Logistics

In order to get your notes you could browse and add them to your portfolio one at a time. At this amount you would expect $375 in payments monthly at a 15% rate. This means each month you will need to buy an additional 15 notes. This would not be bad if you could do it in one sitting, but often the notes will get funded at different times, so you may get $20 one day and $5 another. However, LendingClub has an API which you can connect to in order to do your purchases automatically. Since I’m unwilling to try to do this, I use a third-party service called Interest Radar to do it for me. I can log into their website and set my purchase criteria. I tend to buy notes with lower ratings such as D, E, and F. I can also set it to only buy notes of people with a mortgages, several years credit history, no delinquencies, and many more criteria. This service costs me $60 annually but saves me from having to log in frequently to browse and buy notes.

Returns

Returns vary depending on what type of loans you choose, but in general, the riskier, the more higher the interest rate and hopefully your return. If the interest rate for a good borrower is 6% there is no way you could make more than a 6% return. However, the high-end has rates of 28.99%. You will earn more with a higher rate, but it is also more likely that the person will default and you will lose money on it, so diversify.  Here are some good statistics showing returns of many users.

Strategies

You can try to analyze the data and a good website is Nickel Steamroller to do so. I tend to prefer higher returns so I go for riskier people who are refinancing their debt. You can build your own strategies as you go.

Taking money out

The loans are either 3 year or 5 year terms, so one method would be to wait until the period is over to get all your money and interest. However, if you want to get the compounding effect then you’d need to reinvest each time  you get payments. There is another option, selling notes. There is a platform linked to LendingClub where you can buy and sell notes. I am always willing to sell my notes at more than they are worth because it will boost my returns and allow me to replace it with a new note. However, if you are in a bind and need to get your money out then you can sell your notes at whatever price. The more discounted you sell them, the quicker they should be sold. There is liquidity in the market, but it is not perfect and you will likely have to take a cut when selling but usually just a few percent.

Fees and taxes

Each time a borrower of a loan you hold makes a payment LendingClub will take 1% in fees. Also the trading platform will take 1% of your note’s sale price.  The taxes you will pay on earnings are as interest which is considered ordinary income.  This will lower your returns, so I like to invest with a Roth IRA so it can grow tax-free.

Conclusion

I like LendingClub because it offers me a type of investment that is not available anywhere else.  I know credit card companies give out generous bonuses but still manage to make lots of money on those who pay interest on their bills.  I feel that peer-to-peer lending is similar to being a credit card company in that you are lending with a high return but expect some people to default.  Finally, as mentioned several times this is a risky investment so please be careful, follow the requirements, and do your research.  Should you decide to sign up you can get a referral bonus up to $1,000 through my links for investments starting as low as $10,000.

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