Does Lending Club Work?
Peer-to-peer lending has been around for a few years now, and two of the biggest players are Prosper and Lending Club. I’m going to talk a little bit about Lending Club since that’s the service I’ve been using and have the most experience with.
To give you a quick primer on peer-to-peer lending, it’s a relatively simple concept. Individuals use the power of the internet to get matched with others for their lending and borrowing needs. For example, instead of going to the bank and asking for a loan, I could hop on Lending Club and ask for a loan. My request goes up on the site and people who are looking to lend money could personally fund my loan. So instead of relying on a bank, I rely on individuals to provide the financing I need.
The benefits are two-fold. People looking to borrow money can often do so with better interest rates than what a bank would offer or the interest rate on a credit card. People looking to lend money have an opportunity to help people while earning an attractive interest rate.
Becoming a Lender
I’m going to focus on lending money since that’s what I do, and I suspect what most people reading this are looking to do. So, just how easy is it to lend money and start earning interest? To put it simply — very easy.
The sign up process is pretty straightforward and its the same process you’d go through if you were to open any sort of bank or brokerage account. It will ask for your personal information and some basic questions to get started. The main thing you will need to do as a lender is link your Lending Club account to a bank account so you can transfer funds back and forth. I’m not going to walk you through that process as it’s pretty self-explanatory.
Once your account is open and funded you can begin funding loans and there are two ways to accomplish this. You can select a pre-allocated portfolio of loans based on risk level, or you can create your own custom portfolio by picking and choosing the notes you want to fund. There isn’t a right or wrong way to do this, it just depends on how much work you want to put into it.
Finally, Lending Club takes care of the rest. They handle getting the money from the borrowers, calculating interest, collecting late fees, and everything else. Then they go ahead and funnel the money to your account where you’re free to reinvest it in new loans or send it to your linked bank account. It really couldn’t be easier once you’ve created your portfolio.
My Lending Club Account and Experience
Now that you understand the basic process, I wanted to give you an idea of what you can expect once you’re up and running and share some of the things I’ve picked up from it.
I went ahead and customized my own portfolio by picking and choosing who I lent money to. Loans are graded from A to G with A being those with the highest credit scores and G being those with the lowest. Even so, you need at least a credit score of 660 in order to use Lending Club, so there is some assurance that you aren’t going to have many total deadbeats. That being said, I still didn’t want to get too crazy with my first set of loans so I kept the bulk of my money in A through D which put the average interest rate between 8-14%.
Return So Far
Here you can see my performance thus far. I’m pretty happy with around a 12% annualized return and the fact that all of my loans are still current. It’s still pretty early in my 3-year term for these loans so that could always change, but so far so good.
My Individual Notes
I wanted to give you an idea of how you can track each individual note. As you can see, I invested just the minimum $25 in some, and up to $100 in others. The notes that I put a little more money into were generally funding causes I believed in and wanted to help out with, or for borrowers who I thought were more likely to pay off their loan. The credit grade is helpful, but I know that a credit score doesn’t paint the whole picture and you can learn a lot about the borrower by reading their borrowing statement. As you can see, even someone I invested in with a relatively low grade of D actually paid off their loan in full early.
Trading Notes in the Secondary Market
One of the main drawbacks people have found with peer-to-peer lending is that the loan terms are typically three years. So, what happens if you decide you want out early? You used to be stuck. Now, you can actually trade your notes on an open exchange. This would work pretty much the same as if you were to buy or sell bonds in the market. Here’s what a screen from the trading platform looks like when searching current loans being offered:
You’ll see a lot of good information here. You’ll see the current interest rate, loan status, credit score changes, outstanding payments, and most importantly, the yield to maturity. The YTM basically tells you what you’d earn in total on that note if you bought it for the asking price and if they borrower made the remaining payments. You want to be careful as there are people who put a significant markup on their asking price and it could leave you earning very little or even nothing over the remainder of the loan term. But it’s nice to know that there is an active market out there available if you find that you would rather unload your investment early.
Who Should Invest With Lending Club
The most common question I hear is asking who should invest with Lending Club. First, you need to understand where this type of investment fits in your overall portfolio. It’s important to realize that this is not a place to park emergency savings. Remember, this isn’t an FDIC insured bank account and there are liquidity issues to take into account. So you should go into it thinking about only using money you won’t need for 3 years.
In addition, you should think of Lending Club the same as you would corporate and high-yield bonds. After all, you are lending money just as you would if you were to buy individual bonds. That being said, you can earn decent interest, but there’s also the possibility that your borrower won’t hold up to their end of the agreement and default. While it doesn’t happen all that often, you need to plan for that. You can help minimize default risk by diversifying your investment across dozens of loans or only choosing the highest quality notes.
So, if you have money that isn’t needed for emergency savings but you’re looking for a possible investment where you can earn more than a few percent, Lending Club might be a good fit. At the very least, it’s kind of nice to know that you’re helping real people instead of helping some big corporation somewhere. It is rewarding to know that you helped play a part in helping someone get out of debt or fund their new business. If this sounds like something you’d like to do, I encourage you to give it a shot.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.