Lending Club

Dabbling in Peer-to-Peer Lending with Lending Club

Lending ClubWhen it comes to my investment strategy, I have always been conservative and have always had a one-track mind. Vanguard index funds were all that I needed. The simplicity, the results, and the low expenses had me completely hooked and I had no thoughts of straying from that path.

That is, until recently.

Suddenly, I am trying out new strategies, using different channels, I’ve already discussed how I’ve jumped in to real estate investing (I spent many hours, researching and learning beforehand, don’t worry) and now I’m writing a post about peer-to-peer lending! What’s going on with Mr. NYBudget?

Well, let’s back up. First of all, what is peer-to-peer lending and what role does Lending Club play?

Lending Club – The Basics

You can think of peer-to-peer lending just like any other bank loan. A person approaches a bank and asks for a loan. The bank gives that person money, which they must then pay back in regular installments with interest added in to each payment. Peer-to-peer lending is similar, except that YOU are the bank. You are lending people money to create businesses, pay for education, etc. Similar to how Kiva.org works, you don’t have to lend the entire amount that the person needs. You lend $25 at a time and hundreds or thousands of other lenders chip in $25 as well until the loan is fully funded.

Because the minimum you can loan to one application is $25, you have the ability to diversify by making small loans to a LOT of different people. That way, if one person defaults, you are only out a maximum of $25 (less if they default partway through their payments).

Lending Club facilitates all of these transactions and takes a cut. From their website:

We collect fees from both borrowers and investors.
If you are a borrower, you will pay a one-time origination fee that ranges from 1.11% to 5.00% of the loan amount, depending on your loan grade (A-G) and term.  For more information, please visit our Rates & Fees page.
If you are an investor, you will pay a service fee of one percent (1%) of each payment received from the borrowers.

And that’s pretty much the setup.

My Strategy

The loans that Lending Club features have grades. A-rated loans are ones that they believe are the safest. The borrowers are most likely to pay those back and not default, based on credit score/history, and indicators from their loan application. However, the A-grade loans will also pay you the lowest interest rate percentage (about 6-8% annually). On the other end of the spectrum, G-grade loans are riskier, but pay 20-21% interest rate.

After reading and research, I found that the best strategy is to fund the lower grade loans because the higher interest rate more than makes up for the increased risk. Also, the fact that you are so well diversified across many loans helps lessen the risk of those lower-grade loans. If I put ALL my money into one loan and it happened to default, I would NOT be happy. However, my loss of one $25 loan can be absorbed by the hundreds of other loans that are being payed on time. Diversification helps smooth out your risk.

So I went aggressively after low-rated loans. I used a site called Nickel Steamroller to set up alerts. Every time a high-interest loan that met my criteria (no loan consolidations or credit card debt, no previous defaults), I would get an email. Now, these loans get funded FAST, so at 9:05 am, 1:05pm and a few other times throughout the day, I would get an email alert and I would have to JUMP on those investment opportunities. I would sign into my account and fund each one manually. It took me a LONG time to use all the money I had deposited into my account and was taxing. After a few months though, I was doing well! Seeing returns in the 20% (annual) range!

Then, Lending Club came out with automatic investing and I decided to hop on that bandwagon. You can choose to favor lower-grade opportunities, but otherwise, you can’t specify your criteria like you could with Nickel Steamroller. My percentage return suffered. I am currently around 18%. However, I will gladly take that hit in order to sit back and avoid the crazed race to invest at 9:05 every morning!

What’s Next

Honestly, I’m pretty pleased with how Lending Club has performed. With real estate, I really believe in the principles and I believe in the turnkey company that I chose. However, Lending Club was a bit more of an experiment for me and thus, I chose to start out investing $5,000. Now, that is a decent chunk of change, but not as much as real estate generally requires (at least given my investing strategy).

I have been doing this since October, 2013 (it took me until December to invest that first $5,000) and as I mentioned, I am holding steady at around 18% return. Given that, I may add another $5,000 here in the future.

If you are thinking about investing with Lending Club, make sure to do your homework first and remember one thing. Yes, you ARE diversified through lending to many different people. However, if Lending Club went belly-up as a company, you would NOT be diversified in that sense. I’m not sure exactly what would happen, but I imagine something to the effect of all your money being gone. Lending Club is definitely stable for now and the chances of that happening are slim, but I feel obliged to give you fair warning.

Have any of you invested with Lending Club? Share your experiences! Or feel free to ask any questions you have in the comments!

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13 thoughts on “Dabbling in Peer-to-Peer Lending with Lending Club

  1. Mel @ brokeGIRLrich June 30, 2014 at 11:40 am

    Great look at peer to peer lending! It’s really interesting to me and I love the human aspect of it too – that you’re tangibly helping someone. Your returns are pretty awesome too. I have to admit that I’d never considered the possibility of The Lending Club going belly up though.
    Mel @ brokeGIRLrich recently posted: Accountability: June 2014My Profile

    • Mr NYBudget June 30, 2014 at 1:11 pm

      Lending Club going out of business is admittedly unlikely, especially in the near term, but I definitely wanted it to be a consideration, even if it’s an unlikely one.

  2. Andrew@LivingRichCheaply June 30, 2014 at 12:28 pm

    Interesting strategy. I have a very small amount in lending club (a little over $1000). It’s an interesting concept, but weighing the risk and rewards, I wasn’t sure that it was better than investing in the stock market. You definitely have a much more aggressive approach…I might have to research that. I’m investing in ones that are like Grade C generally. And it’s a bit counterintuitive, but I find those looking at debt consolidation have been pretty decent in repaying. I’ve had defaults for those who borrowed to start a business, medical expense, student loans, wedding, etc.
    Andrew@LivingRichCheaply recently posted: Financial Decisions: Emotion vs LogicMy Profile

    • Mr NYBudget June 30, 2014 at 1:10 pm

      Interesting – good observation. Yeah, I would say that the lower grade loan strategy has definitely worked out for me. The other issue with Lending Club in the long run, is that it is extremely illiquid. I can’t really USE the money until I turn off automatic investing and then wait 3 years.

  3. Aldo@MDN June 30, 2014 at 12:48 pm

    Interesting strategy. We went with the safe strategy and picked mostly A Grade, but our returns have not been so great (~5% because somebody defaulted). Maybe we’ll try your strategy for a few loans and see what happens.
    Aldo@MDN recently posted: Why You Need an Emergency FundMy Profile

    • Mr NYBudget June 30, 2014 at 1:08 pm

      I definitely recommend it. Even if half of the loans default, at over 20%, your net interest rate is still over 10% – and in my experience, nowhere near half of the loans, even the low-grade ones, default. In fact, since September of last year, I don’t have a single OFFICIAL default (although I do have a number of loans with severely late payments that I expect to default soon). Just be careful and purchase enough that you have a statistically significant representation.

      • Doug April 29, 2015 at 11:25 am

        Mathcheck: “Even if half of the loans default, at over 20%, your net interest rate is still over 10%”. If half the loans default you could lose up to 50% of your money, right? So 20% won’t make up for that.
        Am I missing something?

        • Mr NYBudget April 29, 2015 at 11:33 am

          Doug, that was definitely a brain fart on my part. Thanks for pointing this out!

          The idea that the increase in interest rate outweighs the increase in default rate is still holding true for me, though.

  4. Kassandra July 2, 2014 at 4:59 pm

    Your strategy makes sense once you’re willing to absorb potential defaults in order to gain a better rate of return. I have thought about peer lending it but I’ll max out my retirement funds first before I’ll dabble in that.
    Kassandra recently posted: Are You and Your Bank In Love?My Profile

    • Mr NYBudget July 4, 2014 at 12:51 am

      Definitely a wise choice. The retirement accounts and should definitely take precedence.

  5. Hugo Shelley December 27, 2014 at 10:04 am

    Now this is a good read. I never really knew much about P2P lending, but this has given me some great insights.

    Thanks for sharing.

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