Lending Club matches up people who have money and are willing to loan it out with those who need to get a loan.
The theoretic benefit for the “investors” is they earn a higher rate of interest than they could get elsewhere.
The theoretic benefit for those who need a loan is that they can get that loan at lower rates and/or can pay off higher cost loans by borrowing through Lending Club.
Simple – in theory.
What follows is a deep-dive into Lending Club for investors and for borrowers.
You should know that most people who write reviews of companies like Lending Club make commissions when people use those services. And I do get a commission if you take a loan with this company.
So while I have an incentive to get you to do so, I am not going to do that.
My blog income is a small percentage of my overall income and a much bigger concern for me is integrity. So I will be as honest as I can be.
I’m going to show you the beautiful side of Lending Club and I’ll also point out the warts. Then, it will be up to you to decide how to proceed – if at all.
As of October 2018 they’ve funded $38 billion in loans – with more than 2.5 million customers.
They are the first peer-to-peer lender that went public and the company currently has a market value of over $1.8 billion. (But this is down from over $8 billion when they first went public. More on that later.)
How does Lending Club work?
As I explained above, the company matches people who have money with people who need to borrow money. Lending Club acts as an intermediary.
They collect the payments from the borrowers and distribute the payments to the investors – keeping 1% for themselves which is the way they make money.
The interest rate borrowers pay corresponds with their credit history. The better the credit history, the lower the rate they pay with Lending Club.
Currently, the maximum an individual can borrow is $40,000 ($300,000 for business).
Borrowers use Peer-to-Peer lending because they can often borrow money cheaper than from other sources. For many, getting a Lending Club personal loan is a great way to solve debt problems.
For example, let’s say you currently have credit card debt that costs you 15%.
If you have excellent credit, you may be able to get a loan at Lending Club and only pay between 6% and 7%. That’s a huge savings of 8% to 9% for a borrower.
Lenders don’t get the full interest that the borrower pays because Lending Club takes a 1% cut as I said. That’s how they make money.
Still, the investor could make 5% or more (in theory) and that’s not too shabby.
Having said that, I’m going to go on record and tell you that I do not encourage people to invest in these loans.
Taking a loan might be OK (but there are still some caveats) but making loans through peer-t0-peer companies can be risky.
Of course lenders can select the loans they feel comfortable with based on how much interest they want to earn and how much risk they are willing to take.
Each loan is ranked by perceived risk. An “A” ranking is the most secure and an “E” ranking is the least secure.
These ranks are awarded based mostly on the borrower’s credit score. As of October 2018, an A1 borrower might pay 6.11% while a E5 borrower might have to pay 27.27%.
In a few minutes, I’ll explain why I am not comfortable with Lending Club as an investment. Lets first consider this from a borrower vantage point.
Is Lending Club a good deal for borrowers?
For most borrowers, the answer is probably “yes”. I mean, if you can get a loan at 6% or 7% and can use it to pay off a loan that is charging more, what more do you need to know?
But there are a few caveats I’d like all borrowers to consider before pulling the plus:
a. Do you really need the money?
Even if it’s relatively cheap and easy to get the money, it doesn’t mean you should take it.
Of course it’s good to refinance debt to reduce costs. But if you are considering taking a loan to fund some project, think twice.
It’s still going to be expensive to get your hands on this cash. Make sure your project makes sense.
And whatever you do, never borrow money to finance your lifestyle or a smooth vacation. Bad tone Pilgrim.
b. How fast do you need the money?
Lending Club boasts a quick turn around and suggest that many loans can be approved and funded in 7 days. But don’t count on it.
There are many variables and it could take much longer.
If I needed some scratch, I might put in an application with Lending Club – but I wouldn’t stop there. I’d apply other places as well and continue doing so until I got the money I needed.
That said, I think Lending Club does a good job for borrowers. I’ve read many reviews and complaints.
Keeping in mind, 2.5 million customers have used the service. It’s only natural that a handful of complaints would service.
I read through many of them and I don’t think any pointed to a core fundamental problem with the company.
Now lets look deeper at this from an investor standpoint. Here are some of the concerns I have:
Is Lending Club a Good Deal for Investors?
1. Default Rates
Your investment performance with peer-to-peer lending is a function of how many loans in your portfolio default.
If you make a lot of small loans, you reduce the risk that any one default will have a significant impact on your return. That’s true.
But the default rate is still critical. When you invest with Lending Club, the notes are usually for a minimum of 3 years and they could be as long as 5.
I could not find any definitive stats on default rates (red flag warning) but on another site, I saw that they calculated a 5% default rate.
That sounds about right but it could grow higher. Here’s why.
Defaults increase with the age of the loan portfolio. Since Lending Club is making more and more loans each year, that means the default rate could grow.
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?
This issue might explain why the company’s stock price has tumbled from above $25 a share when they went public to about $3.50 these days. Just saying…
In defense of Lending Club, in order to even be considered for a loan, borrowers have to have at least a 640 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, only 10% of the people who apply for a loan at Lending Club actually get funded according to interview I had with a company exec some years back.
Also, as of a few years ago, the average Lending Club borrower had:
- A 706 FICO score
- 18.29% 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
During the interview I had a couple years ago, the executive told me that the most successful investors buy at least 100 notes (minimum investment is $25 per note).
His argument was that the people with a very large number of notes diversify away the risk of having any one bad note impact their overall portfolio.
While the argument made sense, I think a bigger issue is the aging of loans and the risk of greater default over time.
Peer to peer lending companies have a high hurdle to jump over – business continuity.
Specifically, 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?
I was told that the company does have a plan “B”. They have an arrangement with established debt collection firms that would step in should Lending Club step off.
On their site, they did not name those third-party companies. Me no likey.
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 thousands 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 legitimate.
Oh, and by the way, with all due respect, who’s to say you know what you are doing and can really tell the difference?
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. Sorry to burst your bubble friend.
To solve that problem, investors can use tools on the site that selects loans based on filters investors select.
When investors use those tools, it doesn’t take much time at all to get a diversified portfolio of loans. OK – I guess.
I was thinking about introducing Peer-to-Peer lending to clients some years ago but I decided against it.
It all looks good on paper but I just can’t sleep at night knowing my clients are lending out their money to people they don’t know and on unsecured debt. That’s something I need to emphasize.
These loans you make have no collateral. None. Zip. You are shoveling money to someone you don’t know based on their promise to repay you. That makes me very uncomfortable.
To be fair, I decided to kick the tires and I put my own money into the system. I will tell you that Lending Club did 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?
I can’t give it my blessing – sorry. There is just too much at stake.
Again, I feel very comfortable with peer-to-peer lending for borrowers. And for small business owners, there is also the option of applying for Lending Club business loans up to $300,000. Sweet-a-kimbo.
But for investors, there are more risks involved.
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 in 2008. The 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.
If I were in that situation, I’d start the Lending Club pre approval process pronto.
But if you are looking for an investment that is a “safe” way make 6% – 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
Disclaimer – I am affiliate of Lending Club and I advertise their services. That means Lending Club pays me when people borrow or invest using their system if they come from my site.
The information and opinions contained in this presentation are provided by Neal Frankle and Wealth Pilgrim are for informational purposes only and are subject to change without notice. The information contained herein is qualified in its entirety by the more detailed information contained in the offering prospectus (the Prospectus) available from the issuer. Neal Frankle and/or Wealth Pilgrim are not soliciting any action based upon it. The content of this presentation is based upon information that we consider reliable, but neither Neal Frankle, Wealth Pilgrim nor any of its managers or employees represents that it is accurate or complete, and it should not be relied upon as such. An investment in the Borrower Dependent Notes involves significant investment considerations and risks which are described in the Prospectus. Nothing contained herein constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment decision.