Lending Club Review. How to Become a Bank.

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 Lending Club. Lending Club is a peer-to-peer lending (P2P) service. 

They offer a higher rate of return (over 9.6%) than many other traditional fixed income investments. Compared to other types of investments, 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.

Lending Club Loan

Some background on borrowing from Lending Club first. Applicants apply for a Lending Club loan online. They 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, and 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 to traditional banks, and currently start as low as 6.78% APR.

The interest rate, and term is a fixed 3 or 5 year loan. 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, lets discuss how to get started. 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.

Lending Club Investing Requirements

Unfortunately not everyone can invest in Lending Club, and isn’t available in every state. The requirements are:

• 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 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 To Start – 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, 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 every note I wish to fund. I filter my selection 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.
• 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 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, then 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 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 Lending Club called 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.

In my opinion though, this section of the Lending Club site is not to usable in it’s 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 300 notes (otherwise $7,500 or more) invested with Lending Club.
• Liquidity Risk – Loans can be sold on the secondary market, but 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 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).

Lending Club investments might be best suited in a Roth 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.

My Investing Returns

I started with Lending Club in May 2009 with just $1,000 ($925 deposited, $75 in sign-up bonus) in my account. As of today, I have over $7,000 invested and my current NAR is 11.19%. I have over 360 loans, and only 4 have defaulted.

Believe it or not, my performance from my peers in Lending Club is in the 59 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 statistical grouping.

Peer To Peer Lending Resources

I recommend visting the following web sites to help increase your Lending Club returns:

• Social Lending Network – Peter’s is a great resource for the latest happenings in the P2P lending/investment space.
• Lendingstats.com – Great resource to maximize your Lending Club returns. You can create various filter models to increase your returns. Unfortunately the web site isn’t the easiest to navigate.
• Nickel Steamroller – Has many useful tools such as: portfolio analyzer – get your real APR return, and Secondary Market Portal – makes Lending Club’s FolioFN useable.

Disclosure: I have over $7,000 invested in Lending Club notes.