Did you ever wish when applying for a bank loan that you were the loan officer sitting on the other side of the table? Now you can with Lending Club. Lending Club is a peer-to-peer (P2P) lending service.
Lending Club Borrowing Process
Some background on borrowing from Lending Club first. Applicants apply for a Lending Club loan online. The applicants must have a FICO score above 660, which is above subprime. Over two-thirds of the loan applications get rejected by Lending Club. Only a small sub-set of individuals get approved, which is part of the risk management they perform.
Borrowers can apply for a loan from $1,000 to a maximum of $35,000. The interest rate is determined by Lending Club and based upon the applicant’s credit rating. Rates are very competitive when compared to traditional banks and start as low as 6.78% APR.
The interest rate is fixed for the term of the loan. There are three and five year loans available. All loans are unsecured lines of credit and no different than credit card loans. Also, like credit cards, any defaults are reported to the three credit rating agencies (Equifax, TransUnion, and Experian).
Lending Club Investing
Since this is a blog about investing, let’s discuss how to get started. The sign up process as an investor is simple and takes a few minutes to complete. You can fund your account either via an electronic transfer from your bank, mailing in a check, or, for instant availability, using PayPal.
In my case, I choose PayPal to fund my account, so I also got credit card points in the process. Once setup, Lending Club requires you must invest at least $25 per note. Notes are graded from A1 (lowest risk/lowest rate) to G5 (highest risk/highest rate), with sub grades per rate.
Lending Club Investing Requirements
Unfortunately, Lending Club isn’t available to everyone. As per requirements by the SEC and each state, Lending Club has net worth and income requirements. Though Lending Club did not perform any means testing to ensure I fit the requirements. So it is possible if do not meet the requirements listed, you can still sign up.
- Income Level – In most states, you must have a gross annual income of $70,000 or more and have a net worth of $70,000 or more. In the state of California, investors must have a gross annual income of $85,000 and a net worth of $85,000.
- Approved States – You can invest if you are you a resident of: California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Kentucky, Louisiana, Maine, Minnesota, Missouri, Mississippi, Montana, New Hampshire, Nevada, New York, Rhode Island, South Carolina, South Dakota, Utah, Virginia, Washington, Wisconsin, West Virginia, and Wyoming.
- Net Worth – If your total net worth is greater than $250,000, there is no annual income requirement. In the state of Kentucky, investors must qualify as an “accredited investor” under the securities act.
- Asset Allocation – Lending Club investors must not deposit more than 10% of their net worth in Lending Club notes.
- $25 Deposit – Only $25 is needed to start.
Lending Club Investing Strategy
Scott Langmack, of Peer Lending Wealth, has an interesting perspective on how to maximize your return, yet minimize your risk. To summarize his info:
- Job Tenure – Look for someone who has a job for a long time (10 years+ being ideal)
- Government Job – Hold some sort of government position in local, state or federal.
- Low Debt to Income ratio – Make sure it is low (sub 30%)
- Debt refinance – Go for primarily people looking to pay off higher interest rates, than the more riskier types of loans (like new business).
- Many small loans – Build up a portfolio of at least 200 notes. The more notes you own, the more even your portfolio’s performance will be. More notes help spread the risk out to many loans, should one default. This then means a recommended minimum of $5,000 to invest. A total of 800 notes being the ideal investment strategy, which means $20,000 to invest.
Let me add to Scott’s recommendations. First of all, like Scott, I do not use Lending Club’s automated investment tool. I manually select every note I wish to fund. I filter out loans based upon the following:
- Loan Term – 36 months only. The additional 2%+/- return for 5 year notes in my opinion isn’t worth the additional risk.
- Interest Rate – Loans D through G only. I used to look at higher quality loans with lower returns, but in my opinion, the risks didn’t justify the returns.
- Loan Purpose – I tend to focus on customers looking to get a better rate and reducing their debt
- Minimum Length of Employment – greater than 1 year. The longer the employment, the better.
- Maximum Debt-to-Income Ratio – 30%
- Credit Score – greater than 678
- Interest Rate – All. Though I trend towards selecting the higher rates. You should own a mixture of loan grades to increase and stabilize returns.
- Delinquencies (last 2 years) – none
- Reviewed by Lending Club – Yes. I prefer Lending Club has checked them over. It gives a better chance the loan will complete and information is legit.
- Verified Income – Yes. At least as the initial search filter I perform. I also look at unverified income applications.
While I do make exceptions to the filtering, I tend to look at the big picture. The question you should always ask, “Will the individual pay back the loan?” and “Are they a good credit risk?”. If you have any doubt in an application, skip it and find a better one.
If currently no good applications exist, wait a few days and check again. There is no need to rush the process. Take your time picking what you consider the cream of the crop, rather than getting stuck with a bad note. Once you purchase a note, it’s not so easy to unload it though there is a secondary market. In most cases, the goal of buying the note is to hold it for the life of the loan.
Lending Club itself has plenty of statistical information, and so does LendStats.com. Analyzing borrowing trends is something I recommend.
Should you want to unload a loan, there is a secondary market from Lending Club called FOLIOfn. This is great if you have a bad performing loan or need cash for other investments. It’s also a great way to pick up notes from others selling.
In my opinion though, this section of the Lending Club site is not too usable in its current form and needs drastic improvement. The searching options are simplistic at best and unlike their new loan search. If this section was improved, it could definitely increase the liquidity of Lending Club notes.
Lending Club Risks
With any investment, even “secure” ones, you have risk. In summary, here are some possible risks when investing with Lending Club:
- Default Risk – Investments are not FDIC insured and not equivalent to bank CDs or treasury notes.
- Inflation Risk – Similar to bonds since it’s a fixed rate, you have the risk of inflation eating at your returns. Though at the high rate of return of investments, this possible risk is minimized.
- Management Risk – Lending Club’s annual fee is 1%; this rate has already increased from I believe an initial 0.5% fee. This fee could increase in the future.
- Callable Risk – Loans can be paid in full early and affect your return. The downside is you will need to find another loan to replace it.
- Company Risk – The SEC filing shows Lending Club invested $2.4 million from October 2008 to March 2009 to co-fund loans. This represents 24% of loans funded during that period. What happens to new loans if Lending Club does not invest?
- Diversification Risk – If you have a small amount of loans, (under 100) one default can dramatically affect your overall return. Ideally you should have over 400 notes (otherwise $10,000 or more) invested with Lending Club.
- Liquidity Risk – Loans can be sold on the secondary market, but it can take some time to unwind every single note. Lending Club is a long term investment.
- Pricing Risk – Lending Club will properly price the borrower’s risk to default.
With the last issue, you can minimize this risk by specifically picking the loans you want to fund. You don’t think it’s a good loan? Don’t invest in that note.
Lending Club and Taxes
Lending Club investments are not considered passive investments by the U.S. Government. This means you cannot lock in the long term capital gains tax rate. Therefore, the IRS taxes any profit as ordinary income (unlike stocks currently though this might change in 2013).
Lending Club investments might be best suited in a self-directed IRA retirement account. It is much more tax efficient than in a taxable account like I currently have. Lending Club does offer IRA investment accounts. To open a no fee IRA, a $5,000 minimum deposit is required. It is also possible rollover your existing 401(k) or IRA account into Lending Club.