Investing With Lending Club: Six Secrets to Higher Yields

I have been investing money at Lending Club for over a year now, so it seemed like a good time to review my progress. While I started small, I have been adding a small amount to my modest portfolio each month. I’ve been lucky to this point; none of my loans have charged off. Here is an overview of my strategy for identifying profitable, relatively safe loans to invest in.

First, a little background for those unfamiliar with Lending Club, directly from their website:

Lending Club is an online financial community that brings together creditworthy borrowers and savvy investors so that both can benefit financially. We replace the high cost and complexity of bank lending with a faster, smarter way to borrow and invest.

Couldn’t have said it better myself. Basically, this is how the process works. Borrowers apply for loans to consolidate debt, start businesses, make home improvements, etc. Their loan requests are made available to investors (people who have signed up as an “investor” and are looking to loan money to borrowers).

If enough investors agree to cover a portion of the loan up to the requested amount, and borrowers agree to terms with Lending Club, the loan is approved and borrowers begin making payments. Each month, a portion of your original investment is repaid, including a bit of interest (minus a small service fee).

Eventually, if the loan is fully repaid you will receive back your initial investment plus interest, an investment that generally yields far more than traditional savings accounts pay. How much more? Well, that depends on the types of loans you invest in.

Borrowers are “graded” by Lending Club based on their creditworthiness, considering a variety of factors. In addition to this grading system, loan listings provide you with a credit score range, credit utilization ratio, debt-to-income ratio, and a variety of other metrics to help make an informed decision. Generally, the riskier the loan, the lower the grade and higher the interest rate.

Most listings also include a discussion thread Q&A between potential borrowers and potential investors interested in learning more about their employment status, intentions for the money borrowed, etc.

At the time of this writing, my net annualized return is running 11.04%. Most of my investments have been in grade A or B loans that meet a set of criteria I’ve developed over the last few months in an effort to avoid charge off (yes, you can lose your money) while maximizing returns.

My Six Secrets for Earning More With Lending Club

1. Invest in loans less than $9,900. Lending Club allows borrowers to borrow up to $25,000, but for me, that’s a lot of burden for someone to take on (even if my portion of the loan is only $25). Requests for an even $10,000 seem fishy to me, too, so I like to invest in amounts less than $9,900. Under this threshold, chances are borrowers are requesting a specific amount for a specific purpose., making it more likely that they will repay.

2. Look for borrowers with debt-to-income ratios less than 15%. The lower the debt-to-income ratio, the higher the chances they will have money freed up for making payments on your loan.

3. Funding progress is at least 70%. If seven out of ten investors were willing to invest, and other criteria has been met, chances are I’ll invest, too.

4. Invest only $25 per note. $25 is the minimum amount allowed by Lending Club, and after experimenting with various amounts, I’ve decided to stick with the minimum amount for maximum diversification. I’d rather have four loans at $25 each than one with $100 exposed.

When I spoke to Rob Garcia, Lending Club’s Sr Director of Product Strategy, he stressed the importance of diversification when investing in Lending Club loans: “Diversification can lead to more steady returns while lowering your risk.  For example, 98.4% of Lending Club investors with 100 Notes or more have experienced positive returns.” See Distribution of Investor Returns

5. Look for borrowers with zero delinquencies…ever. I understand people can change, and past troubles are not necessarily indicative of future troubles. However, I’m investing my money here and I am not into giving second chances through investments. If I want to help someone get a second chance, I’m more inclined to give instead of loan.

6. Do not invest more than 10% of your taxable portfolio in social lending. I’ve been lucky so far earning over 11% and not losing any investment money to charge offs. However, it is possible, so I do not recommend loading up on peer-to-peer loans to chase a big return. As with any risky investment (and I consider anything over savings accounts to be fairly risky these days), I would limit my contributions to 10% of my overall, non-retirement portfolio.

Note: I recommend creating a filter while browsing notes for criteria 1-5. The post How to Earn High Returns with Lending Club inspired this strategy.

A Word About the Ethics of Social Lending

I initially tried Lending Club as an experiment, and before deciding to invest more money I thought long and hard about the ethics of lending money to others. I haven’t forgotten what it’s like to be in debt – after all, I only became debt free in the last year.

I worried that, in a way, I was simply enabling people to borrow money, so I limit myself to those borrowing for consolidation purposes, rather than taking on a project that needs financing. I suppose borrowing is borrowing, but I’d like to think those borrowing to consolidate debt are also interested in eventually paying off that same debt – more so than someone looking to borrow $15k to remodel a kitchen, for instance.

I’m also hopeful that borrowers are obtaining a better interest rate from Lending Club than they were paying to banks and credit card companies. When I was in debt I remember credit card issuers jacking up my interest rates for no apparent reason other than “the economy is bad.”

I suppose in this way, I am making borrowers’ paths to debt freedom a little bit easier. And of course, I like the idea of cutting out big banks and lending directly to borrowers.

In the end, I decided I would invest a small amount with Lending Club, but do so rather selectively in borrowers whose story and financial picture made me believe they would successfully pay off their loan.


Comments

  1. I hate to be the party pooper here, but is there any analysis behind these secrets of yours? They seem more like hunches to me.
    Here’s a real tip. Go to the Prospectus and read it with a fine toothed comb. On page 56 (page 59 of the whole document) of the current version, there is a table that describes the default rate of every grade of loan. If you are looking for high yield, a G2 loan would be suicide with a whooping 32% default rate; however, a G1 loan only has a 10.46% default rate not that much higher than the B5 (6.05%). Yes, that’s high, but safer than 32.52%. Back when they were making 3 year loans, E3 had a default rate around 3%, which at the time was better than some of the B rated loans and probably double the interest rate of the B rated. A D2 loan has a historical default rate of 5.62% which is better than the B5. Usual disclaimers apply (YMMV, History no guarantee of future…).
    1) A proper statistical analysis will tell you if the $9900 limit is safer at producing high yields.
    2) Sometimes, not all debt shows up on a borrowers credit report, so I’m not sure how effective the DTI ratio will be. In statistics, there is a rigid definition for CORRELATION and you need to know if a low DTI Correlates to better loan performance.
    3) This one is interesting, but I think you need to beware. There are some people who put their money on autopilot. They tell LC to invest in a portfolio with a certain interest rate. So brand new loans are listed with money already invested by Lending Club’s computers. It may only be a couple thousand, but on a $20k loan that is a pittance. On a $3000 loan, that could be 30 to 60%.
    4) I agree with this one. It’s the “portfolio theory” as taught in business school.
    5) This one is a good one, but I’m not sure it would stand up to strict statistical analysis. There are other factors that affect this, like how long is their credit history (2 years? 15 years?).
    6) This one sounds prudent, again the portfolio theory in action.
    7) A and B grade loans have very high prepayment percentages (same table on page 56). Early prepayment increases the number of loans you have to sift through and lowers your return. One of my A loans paid off on the first payment and earned me a whooping 17 cents in interest. How does it lower your return? Let’s say you theoretically invested only in A2 loans (12% prepayment). With your first one, it gets fully funded in 3 days, the loan is approved and issued. The clock for the borrower starts at the end of the original 13 day window. You wait a month after that and the borrower prepays the whole thing. Now, you have to take that $25.17 and reinvest it into a new loan. You pick one, it funds in 13 days, you wait a month and again prepayment. You now have gone 2 months and 26 days and have earned 34 cents in interest.
    Here are some things I look for (certainly not secrets to higher yield, but they make me sleep better):
    A) How much do they owe on their home and how much is it CURRENTLY worth (I tell them to go to zillow.com for a current estimate). Lots of equity is a good sign, under water, not so much.
    B) I look for people who answer questions and give “nice” answers. If they can’t be bothered to answer questions, they probably aren’t taking the loan very seriously, same goes for the borrower who insults lenders (it happens).
    C) I always ask them to list their debts, interest rates, and the amount they pay. This lets me know that they are tracking it and trying to make a dent. Some people don’t know, or give vague answers, get defensive, or don’t answer at all. The interest rates lets me know how smart they are…You wouldn’t believe how many people try consolidating a 5% car loan with a 16% LC loan. The amount they pay every month tells me if they can afford the loan.
    D) Lastly, Active duty military get into real trouble if they default on a loan, so they will make every effort to pay.

    I started with $25 in Jan 09. My investment now is around $10k, I’ve got 214 loans, two are fully paid, one looks like it will default (it’s less than 60 days late, but it’s already been turned over to a collections agency). With compound interest, I’m making a hair over 16%, it’s too early though to rely on that, from my research, I believe my loans haven’t hit the default zone yet (12 to 16 months out).
    Sincerely,
    -LL Herndon, VA

    • Fantastic comment! Yes, my “secrets” are mostly hunches, particularly 1-3, based on personal experiences. I certainly appreciate what you’ve shared.

      Those prepayments are a killer. On the one hand, I appreciate getting 100% of my money back (safety), but on the other, it earns a pittance in the scenario you’ve described.

      Hope to hear more from others.

      • Nope, that’s USMC RETIRED from Virginia Beach. I’m -LL Herndon, VA. And yes, I do ask a lot of questions. You really need to ask a lot of relevant questions to get at the character of the borrower.

        • I checked out the prospectus…they posted a supplement where the default rates look more smooth (G1 is now 15ish%).

          I’m pretty interested in starting to invest here. Do any of you have any other tips for me?

  2. Any experience with buying out loans from other lenders? As a resident of NC, I believe that is the only option I have if I want to use Lender’s Club. I looked into it briefly and from what I could tell, it was handled by a third party and looked like it was more trouble than I wanted to get into.

    • I’m not familiar with the note-trading platform, as I have yet to try it personally. Hopefully someone with more LC experience can shed some light on how it works (and eligibility requirements).

  3. Hi Thomas,

    I am in NC and have been using Lending CLub for quite some time — unless someone changed any rules (which I sincerely doubt it), you should be able to invest easily.

    Kudos to both Frugal Dad and Lou for making people aware of this investment avenue..

    • That is very interesting. When I emailed Lending Club support, this is the response I received:

      “As an NC resident you can participate in our secondary market, buying and selling notes. NC residents are restricted from participating in the issuance of notes by state securities authorities.

      You can read more about the trading platform here: https://www.lendingclub.com/foliofn/mainAboutTrading.action

      We are not able to make assumptions when about when or if we will be approved.”

      In addition to that, their knowledgebase seems to suggest that NC is not eligible:

      http://www.lendingclub.com/kb/index.php?View=entry&EntryID=113

      Am I reading something wrong?

    • Interesting, when I go to invest in a loan, it says that

      The Notes are presently being offered and sold solely to residents of the states 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, and are not presently being offered or sold to residents of any other state, the District of Columbia, any other territory or possession of the United States, or any foreign country.

      and when I emailed Lending Club to ask about this, the response I got was

      “As an NC resident you can participate in our secondary market, buying and selling notes. NC residents are restricted from participating in the issuance of notes by state securities authorities.”

  4. im a PA resident…and we too…can only invest using the secondary market..i have done it for several months with NO problems…the website for the trading platform is not great…and i follow a rather manually intensive process, similar to the blogger….so takes time to search and review each loan i buy….just make sure you dont pay ‘above par’…no reason to do that in my opinion…ive found loans to meet my goals…at or below par.

  5. I have thought about LC for a few years and really enjoyed the analysis presented here and the return rates shown (I understand that if I decide to move forward my results will be different). It would be good to see overall how many loans have been funded and how many have defaulted…

    • Hi SKIRK,
      It’s a bit of a slog, but you can see that data. On Lending Club, surf over to their STATISTICS page. Then click on “Download Data”. Every Loan that’s ever been initiated on Lending Club appears here. Current, not so current, Default, even the loans that have been “REMOVED”. Removed loans were listed and may have even attracted a few lenders, but were pulled for one reason or another before the 13 day funding period expired.

  6. For all of those wishing to purchase a specific criteria of loans on the trading floor I would be willing act as an intermediary by investing in $25 notes. I am a resident of FL and can access both the issuance of new notes and the trading floor. I wont take any money up front (I will invest my own money). I will purchase notes based on your criteria Loan Amount, DTI, borrower Grade, etc. and offer it on the trading floor for a price that we agree on before hand. Then you can purchase notes that you have specifically hand picked rather than rummaging through the notes that are available. Anything is for sale for the right price so I will be willing to open up the small portfolio I currently have on LC as well and offer them on the trading floor.

    Let me know if anyone is interested in collaborating that can only purchase notes on the trading floor. I will be happy to make an attempt to put notes up that are what you are looking for.

  7. Interesting concept and I was going to try it until I saw I was excluded due to income limitations of $70K a year. I have some extra money to invest, but can’t do it with LC apparently.

  8. Is there anything like Lending Club for lower/fixed/regular income folks who do not have a high net worth? I have around $2,500 I’d like to invest in this manner.

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