About 1 months ago, I decided to begin investing at LendingClub.com, a peer-to-peer lending platform. Peer to peer lending is a method where investors like you and me can provide micro loans (as small as $25) that get pooled together for someone that needs the loan. These people pay interest rates ranging from 6% with good credit to 20% or more with more questionable credit. LendingClub.com charges a small fee of 1% for the service of pulling it all together, as well as for their significant filtering of loan candidates. In fact, Lending Club claims to filter out ~90% of loan applications.
So far I have been using my account to invest a small amount of funds to learn more about the peer to peer lending space. I'm also testing out to see what type of returns can be achievable through this kind of investing. I am testing the waters so to speak. As someone who lives in a state where the direct investing isn’t allowed (view which states here), I use the FOLIOfn trading platform within Lending Club to make my investments. This does seem to take more time as I have to manually go through each loan individually to see if it fits my criteria. Otherwise there are many 3rd party sites that can help in the filtering of new loans. In my research here are a couple I discovered:
Folio FN(Trading Platform) Advantages:
One of the most desireable reasons to buy secondarty market notes is because not everyone is eligible to invest directly via Lending Club. Truth be known, you can only use Lending Club if you live in one of 26 select states. Everyone residing in the other 24 states (and DC) are out of the running. However, nearly everyone can participate in the note trading platform. In fact, only residents of the District of Columbia, Kansas, Maryland, Ohio, Oregon, Texas, and Vermont are ineligible.
While new loans may take anywhere from 10-12 days to fund, you can buy a note on the secondary market. The transaction will settle within 24 hours. In my opinion, this is another big reason to use the note trading platform. It enables you to be able to put your money to work much more quickly than via direct investments.
You can also pick up decent notes at a slight discount. (This applies to promising/good looking notes. Not just unfavorable ones.) The discounts will be smaller on better notes, but there are plenty of promising notes at a 0.1% to 0.7% discount. That may not be much of a discount, but personally...I’ll take it.
Reducing your Risk:
By investing on the secondary market, you can screen individuals out by only investing in notes that have received at least one (or a few) payment(s). While an established payment record doesn’t guarantee that a borrower won’t eventually turn into a deadbeat, it does get rid of the outright scammers.
Process of Selecting Notes:
Even though I've only recently begun this style of investment strategies, I hope the sharing my process is helpful.
Unfortunately, FOLIOfn only has basic filtering capabilities. (You can filter based on interest rates, payment status, and the number of payments remaining.) My primary considerations here are status and number of payments remaining. By setting the status to “Never Late” and the number of payments remaining to “32-34” guarantees that there’s been at least one payment made. At this juncture I now have a large number of loans to choose from. I sort them based on their “Markup/Discount” with the largest discounts at the top.
Another major consideration at this point is the borrower’s credit score change. There’s a column for this in the resulting data table, with an arrow pointing up (increase), down (decrease), or across (no change). From here, you simply look for notes that have had no change (or an increase) in the borrower’s credit score. This is when I click to load each of them in a new tab. Now I can simply flip through the tabs and click the “Original Listing” link to load the original loan application. At this point I can quickly check the loan against my loan selection criteria above and close tabs that look undesireable to me. Now I can navigate back to the list of loans, check off those that I want to buy, and submit my order. Simple!
After a little practice, I have no difficulty identifying and ordering loans much quicker. Now when I hop on each day, it is much simplier to purchase 1-3 loans that fit my criteria. Just and FYI: If you place your order before 2:30 Eastern, your trades will settle that day. Otherwise, they will settle at the end of the next business day.
Note Trading Platform Downside:
One of the main downsides of the note trading platform on the Lending Club is directed at the interface. At its worst, it can be extremely slow, the filtering is quite limited, and the order submission process.
Another minor issue was that, of my 60 loans that I have purchased, 5 of them ended up getting cancelled. This money was credited back to my account and the loan sent back to the original seller. This happens when a payment comes in before the sale is completed, the accrued interest plus the principal portion of that note would end up in the seller’s account, thereby reducing its value. Because this has an adverse impact on the buyer, the transaction gets scrubbed and you get your money back.
Diversification on Lending Club
As you can see from the above screen shot, I have $1300 in my Lending Club account. Nearly all of that (except the $70.22 in available cash) is invested into loans. I have investments in 60 loans currently(some of which have not cleared). I do try and keep each investment to about $15-$25 to maintain diversification. If any one of the loans were to go into collections and then be written off, I’m only loosing a small fraction of my overall portfolio, and the hit would be minimal.
Much like any other investment, whether it be in stocks, real estate, etc, diversification can greatly improve your risk tolerance. The risk of having one or two loans that go bad is far outweighed by the fact that you’d still have 10, 20, 30, or more loans that are in a current status. I’ll continue to monitor for loans that go past due and then decide individually whether to keep them or to try and liquidate them through the FolioFN trading platform.
My Lending Variables
There are many variables at play in a loan, so I wanted to figure out which variables led to defaults so I could avoid those types of loans. I generally use Nickelstreamroller.com and Lendstats.com, to analyse which loans provide the best historical loan performance data from Lending Club. My goal is to average between 12-15% net annualized return. Here are the variables I generally look for when picking loans from FolioFN at LendingClub.com.
- Credit Grade: B3 – G5. I started off with B loans but have been recently purchasing more C's and D's. This is critical for high returns. D1 credit grade starts at 16.5%. If you invest in A1, you’re only looking at 6.88% minus fees and defaults. The data shows that default rate does not scale with the interest rates, meaning the riskier loans will return more on average. Diversification across many loans becomes critical. Here is my current loan make-up:
- Loan amount: 0-35000. The data showed that the larger loans were not riskier, so I am not avoiding them unlike many of my peers using Lending Club. In general I tend to go with small loan amounts.
- Loan purpose: Credit Card, Debt Consolidation, House, Home Improvement, and Weddings. I do not include things like car purchases, education, vacations, or small business costs. All these categories are all more likely to default and it makes a lot of sense. Lending Club does not have extremely low interest rates, so anyone that is using them to buy a car or go on vacation is not very good with their money.
- Minimum Open Lines: 6. This shows that the candidate does have several open lines of credit in good standing. Less than 6 is unusual, especially because I think Lending Club filters many of them out.
- Total Lines: 15. This proved the candidate has had enough likes open over the years to build some credibility.
- Income. I generally like to see that the income has been verified and that they have greater than $4500 per month in Gross Income.
- Minimum Employment Length: 4 years. This proves the candidate has reliable employment. Losing ones job is the most common reason for default.
- Home Ownership Status: Own or mortgage. I did not include renting. Not that I have a problem with people who rent, but it reduced the returns by 1%.
- States excluded: For now I have not worried to much about which state the borrow comes from but risk-averse lenders may want to consider excluding borrowers based in Nevada, Florida, Georgia, and California.
- Payment History. Generally I like to find loans where the customer has made 4-6 payments without being late.
- Loan Amounts. 95% of my loans are less then $23. There have been a couple that I have purchased in the $30 range.
I plan to continue this experience by updating everyone with monthly and quarterly reports. I plan to spend more time on the quarterly updates not only for my readers but for my own analyse of my loans.