You may have heard of Lending Club and to help you decide whether or not to use them, I’ve written an extensive Lending Club review.
They claim to be the biggest player in Peer-to-Peer lending. They could be right. As of 5/13/13 they’ve funded $1.7 billion in loans – with $140 million funded just last month.
Peer-to-Peer lending is an industry that matches people who have money with people who need to borrow money. The people who need money pay interest to the people who provide the loans. The interest rate borrowers pay corresponds with their credit history. The better the credit history, the lower the rate they pay with Lending Club.
Borrowers flock to Peer-to-Peer lending because they can often borrow money cheaper than from other sources. For many, it’s a great way to solve debt problems. A typical situation is one that a person has a need to borrow money through Lending Club at (let’s say) 7% in order to pay off credit cards that are charging 15%. The borrower shaves some interest off their payments and the lender makes a lot more than the bank is paying….theoretically. So while this investor hopes this is going to be one of their best investments, the question remains; Is it safe?
Before I answer that question, I need to walk you through the steps of how peer-to-peer investing through Lending Club works. As an investor, you open an account and deposit your money. Then, you select loans you want to invest in based on how much interest you want to earn and how much risk you are willing to take. Each loan is ranked by perceived risk. An “A” ranking is the most secure and an “G” ranking is the least secure. These ranks are awarded based mostly on the borrower’s credit score. This is the part I am a little uncomfortable with.
Don’t get me wrong. I love companies like Lending Club for borrowers. It’s a great business idea. And if I needed money and/or I needed to find an alternative to credit card usury, I’d be the first in line to apply for a loan. If you owe money, you could potentially save a huge amount by refinancing your debt through Lending Club.
But I’m cautious when it comes to investing with this or any other Peer-to-Peer lending firm. I did a little digging and came up with questions. Then, I spoke to Rob Garcia, Senior Director of Product Strategy of Lending Club to get his take on my concerns.
1. Default Rates
Your investment performance with peer-to-peer lending will be a function of how many loans in your portfolio default. That’s why the default rate is critical. When you invest with Lending Club, the notes are usually for a minimum of 3 years. Loans are ranked “A” through “G” to approximate the risk of default. Some time ago, I read on the site that the default rate for Lending Club is averaged for all loans 120 days or older. Sounds good, but my understanding is that the default rate for consumer loans increases with age, even for those who have high credit scores. (I looked on the site and couldn’t see any details about default rates per se other than that the overall default rate is 3%.)
Most Lending Club loans are for 36 months (minimum) and they have far more new loans than old. That’s because they are growing quickly. Lending Club is doing a good job of growing the company. As I said, they issued over $140 million in loans last month alone. So my fear was that the actual default rate may be different than the 3% the site reports. Here’s why:
Say I open an account and make 100 loans in my first year, 200 loans in my second year and 500 loans in my third year. I “invest” as little as $25 per loan so I can easily get lots of diversification. Let’s say that the defaults are zero in year one, 5 in year 2 and 15 in year 3. If you just look at the results for the third year, my default rate is 15 out of a total of 800 loans or 1.875%. That’s not too bad, right? Well that’s not accurate is it? Here’s why. If those defaults are all from the first batch of loans, we’ve got a real problem. If that’s the case, the default rate is 15/100 or 15%. You see where I’m going? The default rate of all loans over 120 days may not mean a lot. And remember that if the loan defaults there is a good chance you’ll lose everything – not just the interest. Ouch.
What would be more helpful would be to know what the default rate is per loan quality per year. They might show this on the site and I didn’t see it but I did look pretty hard and didn’t find it. Also, they might show it in the prospectus but I’m pretty sure most investors aren’t going to look that hard even if they do present the data there. To be fair, the site has a clear risk disclaimer suggesting that investors read the prospectus. They highlight the risks of borrowers failing to repay the loans. When I evaluate mutual funds, I look at the yearly performance. Why can’t I have similar information with peer-to-peer lending?
I brought this up with Rob and he made a pretty convincing argument. First, he told me that in order to even be considered for a loan, borrowers have to have at least a 660 credit score or higher. That weeds out about 50% of all the applicants. Next, potential borrowers can’t have any late payments on their credit report for the last year. That dismisses another 25 % of the applicants. In all, Rob told me that only 10% of the people who apply for a loan at Lending Club actually get funded.
The average Lending Club borrower has:
- A 706 FICO score
- 15.8% debt-to-income ratio (excluding mortgage)
- 14.6 years of credit history
- $70,794 personal income (top 10% of US population)
- Average Loan Size $13,076
He went on to say that investors who are most successful at Lending Club are those who buy at least 100 notes (minimum investment is $25 per note) and the site shows statistics for investors with 800 notes ($20,000 total invested). His argument is that these people with a very large number of notes diversify away the risk of having any one bad note impact their overall portfolio. His experience was that if a loan was going to default, it would typically go sour before the end of the 9th month. This is of course no guarantee. But if true, it sort of takes care of my concern over the aging of the loans.
Rob wasn’t done. He also told me that Lending Club uses debt collection practices on all borrowers who default. This runs the gamut between making nice reminder phone calls, to working out a payment schedule to legal recourse. It’s nice to hear if you’re a lender, you still have a chance of collecting after the loan defaults.
2. Continuity
If Lending Club were to go out of business, what happens to the money you lent the borrower? How are you going to get your money back? Do you suddenly find yourself in the personal debt collection business?
When I spoke to Rob about this he assured me that Lending Club was solid. But even then, the company does have a plan “B”. They have an arrangement with a large established debt collection firm (Portfolio Financial Servicing Co) that would step in should Lending Club step off. That was also reassuring to me .
3. Lots of Work
I was worried about having to do a lot of work to find good loans. It takes time to go through the hundreds of available loans to find people you are comfortable loaning money to. Everyone has a story and you have to be able to read between the lines to determine who is full of it and who is a legitimate person. Oh, and by the way, with all due respect, who’s to say you know what you are doing?
Assuming you aren’t a skilled loan underwriter, you may keep selecting people with a good story but may end up shoveling money towards the worst risks possible. On this front, Rob informed me that investors can pick their own loans. But they can also use tools on the site that selects loans based on filters investors select. Mr. Garcia said that when investors use those tools, it doesn’t take much time at all to get a diversified portfolio of loans.
I was thinking about introducing Peer-to-Peer lending to clients about a year ago. Before I did, I put my own money into the system. I will tell you that Lending Club has done exactly what they said they would. They are a very professional outfit and I haven’t been disappointed by their service. But are personal loans good retirement income investments? Rob Garcia was able to answer my questions. He is smart and thorough. If that’s any indication of the people at Lending Club, I’ll be the first to admit that I’m impressed.
Again, I feel very comfortable with peer-to-peer lending for borrowers, and Rob answered all my questions. For investors, there are more risks involved with Lending Club but a well diversified portfolio can make sure the burn is not as bad as the overall gain if a borrower defaults.
At the end of the day, it takes years to really know the ins and outs of any particular investment and that’s the case with Lending Club and other peer-to-peer lenders. My experience tells me that while Lending Club seems to be a reputable firm, there is still reason to go slow. Think back to the golden age of real estate when uneducated investors threw money at homes they couldn’t afford for reasons they couldn’t explain. The reality of real estate came home to roost and many people got smacked down pretty hard. They same thing happens to many investors who put their money into investments they don’t fully understand.
This is not a simple investment and the risks are different than commonly perceived. For borrowers, this is a slam dunk. If you need money and you are paying high rates, Lending Club is a company I can endorse. But if you are looking for a “safe” way make 9% – don’t kid yourself. That’s because anytime you are offered rates that high, the risks are high as well.
- More information on how to borrow with Lending Club
- More information on how to invest with Lending Club
I also want to be transparent – I am affiliate of Lending Club and I advertise their services. They pay me when people borrow or lend using their system.
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I live in Canada, what are my investment options that are simular to LC and Prosper? Thanks!
about the default rate, about the diversification, this is not stock we talking about where the winner can win so much more money than the loser, in other word, you are not really diversify here, because it will take lots of lots of winner to make up a loser, where in stock, it only take a few winner to make up all the loser, because when the stock is a winner it goes much much higher, however you winner in the peer to peer model only got back the principle and interest, there is limit gain here.
I have a couple of loans through LC and am currently trying to do a settlement with my credit card companies as I lost my job. However, I am NOT even thinking about that for LC. I have every intention of paying off (on time) my loans. If a big bank has to take a loss, oh well. But I don’t want to “stiff” the small private person who is just trying to beat inflation. .
I don’t have any data to cite, but borrowers like Dwayne seem to be quite rare. Wouldn’t it be wonderful it this weren’t true? For one, borrowers would then be facing lower rates.
I don’t think borrowers think about who’s affected by a default beyond themselves and the small lenders.
I have noticed the number of available notes to “browse” is way down. Today there were only 235, usually there were 700-900, and for a while considerably over 1000. Any idea why this is happening?
The number of available loans is way down at Lending Club from a few months ago because there are many more investors now and the loans are being funded much more quickly. There are actually many more loans being added to the platform than ever before, usually 250-300 new loans every day but the average loan is being fully funded within 24 hours today. So the whole platform is much more dynamic than it was a few months ago.
Thanks Peter – that is very helpful, and explains why the borrowers never seem to answer any of the questions I click on anymore! I guess they don’t have to.
Hi Neal. Thanks for your article on lending club. First of all what are notes? and do i have a choice of just leaving my money in my Lending Club account and watch how things goes within the community or does my money i transferred from my bank goes automatically into buying these notes soon as it hits my lending club account . As an investor, should i decide to pull my money out of Lending Club at anytime do i have to sell my notes first or can i just hit a transfer button and get my money back to my external account if i need to use my money for something else? Thanks.
Dave,
I’ve been with LC for close to 5 years. Notes are each individual loan. None of your notes will be automatically invested unless you have a Prime Account. If you want to pull money, you need to sell your loans first. Also, remeber that your notes are being paid daily, so your account accrues balance and interest that have to be re-invested. Or, you can let the balance build up and pull it out at any time via an EFT transfer back into your bank. I’ve done it several times when I’ve wanted to use funds for other things.
I am interested in lending at least 800 notes at $25/each. How many 36-month notes available on Lending Club to invest at any given time?
In order to earn $800/month, it would take a $100k investment at 10%.
I understand that it may take a while to fully fund my investment. Can anyone tell me how long it could take to fully fund 800, 2,000 and 4,000 notes?
The answer to that question is it all depends. Lending Club are adding 300-400 notes a day so it would be theoretically possible to be fully invested in 800 notes in 2-3 days. However, most people do not invest in every note. They do some filtering, whether it be by loan grade, loan purpose, income or many of the available credit criteria. I can tell you that I would spend at least 4-6 weeks investing in 800 notes.
As a new investor, I was very interested in learning about LC and found your article very informative. After reading your article I decided to sign up for an account. Come to find out that since I live in Texas I am only able to trade loans on the secondary market through the FolioFN program. I am hesitant to invest since it seems like the secondary market mainly consists of notes other investors think will go into default. What is your opinion on investing with LC if you can only use the FolioFN program?
I would check out to see if they might be a better solution. If not, I would pass.
Ryan,
I’ve been investing and selling in the secondary market for over 2 years, almost 5 in LC. My current secondary market portfolio contains 179 notes, over 50 were paid in full and the rest are current. I’ve found that many investors monitor the notes credit rating. The minute is shows any drop, no matter how small, they put it up for sale. Those are the notes I buy. I generally purchase all mine on the secondary market. The accrued interest is immediately deposited to your account, where if you buy a new loan, the first payment doesn’t come in for over a month. LC takes monitoring; if you don’t want to monitor, it’s not the right financial vehicle for you.
I do not recommend Lending Club.
I’ve had 200+ loans for over a year now, and have had steadily climbing default rates. I hand picked my loans, using a filter and all are in the A-C range with high credit scores (most over 700-750). I’ll be lucky to break even after the 5 year mark with the amount of loans that are detonating. Im almost to 10% default rate. I expect it to continue rising with the amount of loans they keep expanding, they are adding more and more bad loans to keep up with demand, you can see their charts on how much they are rising each year. Walk away, you’re not going to get 10-14% returns, be happy with 0-5% from these guys.
Brandon,
Are you using the secondary market to manage your “poor loans”? I’ve been invested for almost 5 years and only had 8 defaults. I sell them for a partial recovery, before they get to the default stage, generally as soon as they go into he Grace period.
200 loans is not very many and FICO score is a poor predictor of repayment.
My 1100+ portfolio has only 8 defaults; check the stats for loans defaults by origination year since 2008 ( on the additional stats page). they have settled to around 8% cumulative over all grades. So even if they defaulted early, you should still be able to average ~7% ROI after 3 years in a large enough portfolio.
Does anyone know when Lending Club plans on releasing/filing their 10-K? I thought it was due 90 days from year end which would have been the end of March.
It was released a week ago:
http://edgar.sec.gov/Archives/edgar/data/1409970/000119312513136975/d450565d10k.htm
Peer to Peer?
Are you kidding me? This is a bunch of rich snobs cashing in on the desperate.
Too bad it is not p2p, people willing to help out without maximizing profit. There may be a few people willing to help out, unlike Corporate America, and people that have a few X-tra bucks. Just help out and break even, or even 2%, cripes what have the banks paid you?
Chris,
Banks aren’t paying enough to even keep up with inflation, so everyone – including you – should be finding ways to earn more. Our retirement depends on it.
Many folks receiving these loans are remodeling homes, buying cars and engagement rings, going on vacation, starting or improving businesses, and refinancing credit card debt at lower rates. This all helps them and the economy. Most borrowers are not desperate – they are just trying to maximize their own returns.
Many of the lenders could just invest elsewhere with less effort but have decided to do some of it at Lending Club. And as with any venture for profit they wish to make a decent return. You can’t expect people to “just… break even” on their nest eggs.
Remember… the banks are pretty tight with money these days.
I also make interest-free loans through Kiva. How about yourself? (For as little as $25 you can also help …)
Neal, thank you very much for the great article and to all the fellow comments. I just wanted to pose a simple question.
If I invested 10k right now in LC, and I average 2% roi, so that means I would make $200 dollars in one year? That doesn’t sound that great for the risk. Is this an accurate statement?
Why not just put the same money in xxxx Bank for 1.19% and make a guaranteed $119 dollars? I just am fearful of risking money when the returns are not really any better than a bank. Thanks.
The goal is to earn substantially more than 2% of course but there is risk. So you wouldn’t compare this to a bank account because it has much less risk. LC offers the opportunity for much greater returns but as I said and as you’ve seen, there is some risk.
Mike. See my post of Jan 7, 2013. My 2012 end-of-year statement showes $1795 in loan interest, 0.28 in late fee income (from former charged off loans), $0 charged off loans and $99.43 in service fees. Net was $1696.20. I’ve only had 8 charged off loans and none in the past several years. I dispose of a loan on the secondary market as soon as it goes into the grace period (at a minimal discount) before it goes late or worse. Even if it become current again, I still dispose of it. That way I don’t have to take too deep a discount. I spend 5-10 minutes several times a week monitoring this. I think this is necessary to maximize LC profits.
Julie,
my own experience at Folio (secondary market) has not been as positive as yours. Notes in “Graceland” and beyond almost never have buyers if priced near the cost. They only sell at deep discounts in my experience. Of course, once the lates correct themselves, the notes could sell closer to cost. LC’s estimate on lates’ cure rate is around 50%, but my own experience is somewhat lower than that (more like 30%).
Julie, how do you decide what to price the loans at that you are selling?
Sandra,
It depends on where the loan is. Once it goes into the grace period, I price it just pennies under the loan + interest. Seems like so many of the “for sale loans” are asking a premium. If is goes current again, that is when I’m most likely to sell it. I’ve just sold a couple like this over the last couple of days. If it get’s worse, then I just keep dropping the price until it does sell. Your current asking price is only good for about a week, so you have to keep looking at the progress. I’ve even sold Chapter 7 loans, at a deep discount mind you, but it’s better than defaults. I just posted something several weeks ago about the secondary market on this blog, but it must not have been approved. It’s a great tool to manage “poor loans” rather than just accepting that some of your loans will default.
My 2012 year-end statement shows that I earned $973 in interest but I also had $876 in charged-off loans. After $56 in service fees, I had a net profit of $42.
I invest $50 per loan and have currently been selecting mainly A & B graded loans that result in stimulus to the economy, such as home improvements and business expansion/purchase. I do have older, lower-rated loans. Out of all the defaulted loans since Jan, 2010, ten had ratings of A or B while 28 had lower ratings. I expect this ratio to change since I started to invest only in the A/B loans.
In 2010 with $5000 invested, I had $654 interest with losses of $253. In 2011 with $6000 invested, it was $687 interest with losses of $349. In 2012 with $10,000 invested, it was $973 interest with $876 in losses.
I’ll give them another year but if this keeps up I am going to bail out and put my money elsewhere.
It’s amazing how many people stop paying very soon after they receive a loan. Maybe there are good reasons that banks aren’t anxious to lend money.
I see that your investment continues to grow over time ($5k, $6k, $10k). Did you add more money in increments, reinvest the payments you received or did you take any money out over the years?
Deb, I added money in increments to total $11,000. I showed the approximate yearly averages above. During my 3.5 years, I have netted $860.
I have not withdrawn any funds…
Thanks Mike. I’m not sure I see the upside in this investment. I have other Mutual funds that have made way more than this over the last few years.
I’m still considering it, but don’t know if it is your selection strategy that didn’t work out for you or the system itself.
What happens if the borrower comes back in a couple of years and decides to pay back the loan, even if it is written off or does that never happen after the write off?
Interesting article, however you didn’t explore the issue of state laws on interest rates which limit what a person can charge another person on a loan.
Some states restrict investing or borrowing with LC. I think I did a good job of delineating those states in the post.
If a LC Loan goes into default what type of collection methods besides a negative credit report are employed to get an investors funds returned to them. If a partial return of equity is recovered by means of collections is the investor compensated.
Joel, they turn over non-performing notes to a collection agency. Besides harassing the borrower, I’m not sure they have any real power.
Hi Neal,
Do you know if the LC loans show up on the borrowers’ credit reports? (Even if they’re making payments). I’d hope the LC loans do show up on the borrowers’ credit reports (just like any other loans they have) to prevent them from going out and borrowing more and more.
Thanks,
Angie
I believe they do. I know that LC reports to the credit bureaus when there is a problem with the loan so I would assume that they report when a loan is taken out.
I figured i’d chime in with my experience on LC.
Started back in late 2009 with a small amount, i think a $100, just to test it out and see how the process worked. After a couple months i seen the payments rolling in so i started depositing more money here and there and things were going well. I don’t recall what year is was but LC had a promotion going that you’d get 1% on any amount (over 200/month) you automatically deposited after you invested it, so for a year i was doing auto-deposits earning more on the money i put in then leaving it in savings. I am sitting on over 225 notes now, 7 have been charged off and this took my return from 13% to 9%. I have started using Folio more to try and dump the dead beat notes early on, better to get 30 cents on the dollar for a note with no payments in a couple months then to watch it default.
I mainly stick to debt consolidation, i also look to see if the borrower’s revolving debt is close or greater to the amount they want to borrow. The idea is they are paying off debt and not taking out more then they need.
A couple years ago you could type up a question for the borrower and depending on their response (if i got one) would determine if i lent them money. Now you can only select a question from a list to send. I have noticed that borrowers are getting lazy and don’t even bother to answer the question asked.
Example, asked “List out the debts along with interest rates, balances, and minimums you wish to pay off”, responded “chase and citibank”. So flipping helpful, no money for you.
I have to wonder if LC is getting more investors so some of these borrowers don’t even have time to respond because their loan is approved and funded very quickly.
How does one take cash out – no such details on the LC website. Are there any limitations / penalties based on timing, percentage of total investment, … ?
You can sell the notes if that is what you are asking. You can also get a monthly income from the notes. Is that your question?
You can withdraw any cash that has accumulated in your account at any time. There is no restrictions. I just withdrew an amount that was over 10% of my investment. It was ACH deposited into my checking account. There is a “transfer” link on the site that deals with depositing/withdrawing funds.
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