Investor Junkie
My Business and Financial Freedom Journey

Lending Club Review – How to Become a Bank

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Did you ever wish when applying for a bank loan, that you were the loan officer sitting on the other side of the table?  Well now you can with peer-to-peer (P2P) lending services like Lending Club.  They offer a higher rate of return (over 9.6%) than many other traditional investments and you have some ability to manage risk.  It’s similar in class to bonds, but is more like if you owned a bank and were the loan officer.  You determine which loans you want to approve, and which ones to pass on.  Sounds interesting?  Keep reading for more details.

Borrowing from Lending Club

Loan applicants visit LendingClub.com and apply online.  They must have a FICO score of above 660, which is above the subprime loan category.  Over two-thirds of applications get rejected by Lending Club, so only a small sub-set of individuals get approved, and is part of the risk management they perform.  Borrowers can apply for a loan from $1,000 to a maximum of $25,000.  The interest rate is determined by Lending Club and based upon the applicant’s credit rating.  The interest rate and term is a fixed 3 year loan, and currently do not offer any other loan terms.  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).  For more of a borrower’s point of view, visit the web site DebtFreeAdventure.

Investor Requirements

Since this is a blog about investing, lets discuss how to get started. Do you meet Lending Club’s investing requirements? Here are the requirements:

• 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 $100,000 and a net worth of $100,000.
• 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 great 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 – Only $25 is needed to start.   If you sign up now with Lending Club they will give you an additional $25.

The sign up process as an investor is simple and takes a few minutes.  You can fund your account either via an electronic transfer from your bank, mail in a check, or for instant availability use PayPal.  In my case, I choose PayPal to fund my account, so I also get credit card points.  Once setup, Lending Club has the requirement 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 grade per rate.  As of December 7th, 2009 the rates are as follows:

Once you review and pick a loan it will take a few days before it’s completed.

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:

• Look for someone who has a job for a long time (10 years+ being ideal)
• Hold some sort of government position
• Has a low debt to income ratio.
• Go for primarily people looking to pay off higher interest rates, than the more riskier types of loans (like new business)
• Build up a portfolio of at least 200 notes.  The more notes, the more even your portfolio’s performance.  This helps spread the risk out to many loans, should one default.  This then means a recommended minimum of $5,000 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 the notes I wish to fund.  I filter my selection of notes by the following:

• Loan Purpose – I tend to focus 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 help increase returns.
• Delinquencies (Last 2 yrs) – none
• Reviewed by Lending Club – Yes. I preferred 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 filter.  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 application exists, wait a few days and check again.  There is no need to rush the process and take your time picking what you consider the cream of the crop, then getting stuck with a bad note.  Lending Club themselves has plenty of statistical information and so does LendingClubStats.com.  Analyzing borrowing trends is something I recommend.

Secondary Market

Should you want to unload a loan, there is a secondary market from FOLIOfn.  This is great if you have an bad performing loan or need cash for other investments.  It’s also a great way to pick up notes from others selling.

Possible Risks

With any investment, even “secure” ones, you have risk.  In summary here are some possible risks with investing in Lending Club:

• Investments are not FDIC insured
• 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, this is minimized.
• Lending Club’s yearly fee is 1%, this rate has already increased from I believe the initial 0.5%.  This fee could increase in the future.
• Loans can be paid in full early and affect your return.  The downside is you will need to find another loan to replace it.
• 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?
• If you have a small amount of loans, (under 100) one default can dramatically affect your overall return
• 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.

Taxes

Lending Club investments are NOT considered passive investments by the U.S. Government.  This means you cannot get long term capital gains tax rate.  Therefore the IRS taxes any profit as ordinary income (unlike stocks).  Lending Club investments might be best suited to a Roth IRA retirement account.  I currently have my investment in a taxable account, but Lending Club does offer IRA accounts.  To open an IRA a $15,000 minimum is required.

Current Results

I started with Lending Club this year (May 2009), and put $1,000 ($925 deposited, $75 in sign-up bonuses) into my account. As of today, my current performance is 10.45% with 24 loans.  I have it as a small part of my security bucket.  Believe it or not, my performance from my peers in Lending Club is in the 39 percentile, not great and I hope to increase in the next year, with better note selection.  The average return is 9.67%, and I’m in that most common grouping.  I currently have no defaults, and monitor my loans closely.  Based upon Scott’s results, defaults tend to increase up to the 18 month mark and quickly decrease after that hump.

For next year my goals are:

• Adding an additional $2,000, with the final goal of $5,000
• Invested with 100+ loans.
• Perform this over a three year period and invest a little at a time.  This allows me to closely watch my returns, and smooth out returns at the same time.
• Searching the secondary market (FolioFN) more for any good loans to acquire.

Disclosure: I have $1,000 invested into Lending Club loans.

Created: Tuesday, 8 December 2009 09:00 Last Updated: Saturday, 29 May 2010 11:17 Written by: Investor Junkie