Peer Lending Investing lets you in on the profession of the super-rich, follow this Lending Club review and learn how to be a Fat Cat Banker
I’ve always loved reading about financial history and I’ve always been a little jealous of the famous banking families. From the Rothschild family to the Medici, the owners of finance have always enjoyed a privilege of which the rest of us could barely dream.
In fact, possibly the only easier way to make money other than owning a bank is to own a casino.
It only took a little over 600 years of organized banking but regular people like you and me can now be the fat cat banker. Peer lending sites like Lending Club allow you to make loans directly to borrowers, collect the interest and plan your family legacy as only the 1% could do before.
I’ve already talked about peer lending and investing in p2p loans a few times on the blog. One of my first posts was an interview with a peer lending investor that has booked over $10,000 in profits and a 12% annualized return over the last six years.
After talking with the Lending Club investor, I opened my own peer lending account and now have more than ten grand of my own money in loans.
For this post, I wanted to take a closer look at the world’s largest peer lending site. I wanted to share how I set up my own peer lending investing account and some of the Lending Club investing strategies I’ve used over the past year to earn a return on my money.
Use this Lending Club review to understand the peer lending process and how you can open your own bank to make money on peer loans.
Lending Club Review: How to Open a Bank
Lending Club was founded in 2006 as an online credit marketplace. It’s basically just a website that connects borrowers with investors and takes a fee off the top. Unlike traditional banks, Lending Club doesn’t take any risk with loans so there’s no chance that the company is going to go belly up on the next financial crisis.
There’s really nothing new in peer lending investing. Big money managers and pension funds have been buying bank loans for hundreds of years. Investors get safe investments backed by loan agreements and the bank gets more money to make loans. The only difference now is that peer lending investing allows regular people to buy loans and not just the richest 1% of investors.
Lending Club has helped fund nearly $25 billion worth of loans to December 2016, with more than $2 billion of that just in the last three months. In fact, Lending Club has nearly doubled the amount of loans it funds each year. Former Secretary of the Treasury Larry Summers believes that Lending Club could, “profoundly transform traditional banking over the next decade.”
The way Lending Club works is surprisingly simple. Borrowers fill out a loan application just as they would for a traditional bank loan. Personal loans are available for up to $40,000 while business loans can be made for up to $300,000 and on fixed terms up to five years. Lending Club checks the borrower’s credit report and assigns an interest rate and risk category on the loan.
If the borrower accepts the terms, the loan goes live on the site and investors can decide whether they want to invest from $25 per loan. Once a loan is fully funded, the borrow gets the money and pays Lending Club directly each month. Investors are repaid interest plus principal on a monthly basis until the loan is paid off.
Check out loans available on Lending Club for investing. Click to open a free account and browse loans.
Loans are available to borrowers in nearly every state with most loans going to pay off high-interest credit cards or for debt consolidation. With the average credit card rate of 17.5% according to Credit Card Monitor, borrowers stand to save big money by refinancing into a lower-rate peer loan.
Review the Lending Club loan data and you’ll find that most borrowers are doing pretty well financially. The average borrower has a credit score of 700 and over 16 years of credit history. They are doing pretty well with an average $74,414 in annual income which puts them in the top 10% of U.S. workers.
These are loans that go on the borrower’s credit report and will damage their score if they miss a payment. Portfolios of hundreds of loans are going to have at least a few defaults but the majority of borrowers aren’t going to risk their credit score on a loan of a few thousand.
Other than picking loans for your portfolio, Lending Club handles the entire lending process for investors. The site charges a 1% fee on each payment received to cover the costs of collecting and distributing payments to investors. If a borrower does not make their payments, Lending Club passes the loan to a collection agency which charges a fee on any money recovered.
I’ve talked to a lot of investors that think Lending Club loans are too risky. The ability to pick which loans in which you invest according to borrowers’ credit risk means you can fine tune you return and risk. Most of the Lending Club investing strategies I follow invest in the top three borrower categories for stable returns and limited risk.
How to Get Started Investing on Lending Club
Opening an investment account on Lending Club is a pretty easy process so we won’t spend much time on the review. You’ll first decide whether to open a regular investment account or a tax-deferred investment account, more on the advantages of this later.
After filling out your contact and tax information, you can transfer funds from your bank account through an automatic transfer, wire or by check. You need to be at least 18 years old and have a verifiable social security number. Some states require that you have a minimum income level, usually about $70,000, or have a net worth of over $250,000 to qualify for investing on Lending Club but the site is not required to verify the income or net worth that you report on your application.
There is no minimum amount for investing accounts but you will probably want to start with at least $2,500 to make sure you can buy enough loans for investment diversification.
How to Pick Loans for your Peer Loan Portfolio
Once you’ve funded your Lending Club account, you’ll want to start picking loans in which to invest. Money just sitting in your account isn’t going to earn anything so you want to stay as close to 100% invested as possible.
Investing on Lending Club and picking loans for your portfolio should always be done as a part of an overall investment strategy built on your own needs and tolerance for risk. Think of peer loans as an asset somewhere between bonds and stocks. Peer loans are fixed-income investments, with a set interest rate and maturity, but they offer returns closer to what you’ll see in stocks. The loans are not secured on any property like a mortgage but do get reported on the borrower’s credit report.
Adding peer loans to your investing strategy can actually lower your risk in a portfolio of bonds, stocks and real estate. Since peer loans pay off more quickly than longer-term bonds, interest rates won’t have as much effect on the investment. Even though the loans are unsecured, the average borrower is financially secure and payments should hold up well in an economic downturn.
Lending Club separates loans by seven risk categories according to the borrower’s credit history and loan terms. Loans in the safest category have a default rate of just 2.5% but offer the lowest return. A return above 5% may not seem so great against rates in the other categories but the loans are extremely safe and still very attractive when you consider returns of less than 2% on similar corporate bonds.
As you consider loans in riskier categories, understand that you’re going to have more than a few defaults. The default rate on loans in the E category is 11% which means that for every 100 loans you hold, you could see around 11 of them not pay off. It can be difficult and even frustrating to see a borrower stop paying but understand that it’s not personal and is just a fact of being a bank.
The chart above shows that even on higher default rates, the average return on riskier categories is still very good. A few loans may not pay off but the ones that do pay so much interest that you can still earn upwards of 10% a year.
The Lending Club investment screen shows bonds available by several factors. You can invest as little as $25 in any loan and can screen the loans according to different criteria. Loans for 60-months and for higher amounts tend to pay higher rates compared to shorter-term loans for smaller amounts.
When you’re ready to invest in a loan on Lending Club, all you have to do is put in an amount for ‘Investment’ and then click ‘Add to Order’.
Lending Club Investing Strategies
Just as with stock market investing, different investors will need different p2p investing strategies. If you are a younger investor with a high tolerance for risk, you might choose to invest in riskier loans for higher returns. If you are a retiree looking for monthly income then the safest loan categories will be more appropriate.
Don’t think that peer loan investing is just for a certain type of investor. P2P investing is for everyone and there are investing strategies that will work with any needs.
Choosing loans with special criteria is the best way to make a higher return and lower your risk of default. There are plenty of Lending Club investing strategies for picking loans but you don’t really need to get too complicated in your criteria.
Through my own special Lending Club investing strategy, I’ve been able to reduce defaults to about half the rate on all loans. With fewer loans not paying out, my returns jump higher and I’ve averaged between 9% to 11% over the last year. I like to invest in loans with the following criteria:
- Maximum debt-to-income ratio of 25% for borrowers, meaning they spend less than a quarter of their income paying off debt each month
- No delinquencies on loans in the past two years
- A good work history with preferably 5+ years in their job
- Borrowers that own their home with a mortgage are generally more stable and won’t default as much
- Peer loans within the middle risk categories, from B through E
This Lending Club investing strategy doesn’t guarantee that the loan will pay off but the default on my portfolio has been lower than the Lending Club average and returns have been higher. I like to invest in loans across categories B through E which gives me a good trade-off between risk and return.
At times, it might be difficult to find enough loans that fit your criteria exactly. You might have to relax your criteria a little to invest all your money or increase the amount you invest in each loan. I invest between $75 and $150 in each loan and try to keep around 150 loans in my portfolio. This means that any one loan is only about 0.7% of my portfolio so a default isn’t going to hurt my returns much.
For investors that want less risk in their peer lending investments, I would suggest you stick with the first three risk categories of loans plus the criteria above. This is a safe Lending Club investing strategy but can still provide stable monthly income and annual returns of 6% on your money.
|Type of Investor||Best Lending Club Loan Categories||P2P Loan Criteria||Expected P2P Investing Return|
|Needs reliable income, low risk||A, B||Home owners, income verified, debt-to-income <20%||6.5%||Click to Start Investing|
|Reinvest money but does not want much risk||B, C, D||Mix 36- and 60-month loans, no delinquencies, home owners, DTI < 30%||8.5%||Click to Start Investing|
|Long-term and wants to maximize returns||D, E||60-month loans, no delinquencies, DTI < 30%||10.5%||Click to Start Investing|
Lending Club also offers a cool automatic investing feature. You set the criteria for the loans in which you want to invest and the site will automatically invest your money in those loans when they become available. Peer lending investing is becoming so popular that loans can get funded really quickly so automated investing is a good way to get access to all the loans you want without having to log in and manually invest all the time.
Since Lending Club doesn’t charge you each time you invest in a loan, it is easy to reinvest your money. This is a problem with bond investing and other fixed-income investments because you usually have to pay a trading fee to reinvest your regular payments. On Lending Club, you can set up to automatically invest the cash in your account when your loan payments come in without worrying about fees.
One of the best strategies for investing in peer loans is through a tax-deferred individual retirement account (IRA). Lending Club allows you to open an IRA account and invest for retirement. Any money you put in the account gets taken off your income so you don’t have to pay taxes in the current year. Your interest payments from loans are not taxed until you withdraw the money in retirement.
Since interest you earn on peer loans in a non-retirement account is taxed as regular income, the tax advantages of an IRA can be huge. For someone in the 28% income bracket, you’ll save $320,000 in taxes on a one-time deposit of $100,000 and an annual return of 7% in an IRA account rather than a taxable investment account.
I shared three Lending Club investing strategies for different types of investors on my investing blog earlier this year. Click here for ideas on investing on Lending Club that are right for your needs.
Is Peer Lending Investing on Lending Club Safe?
Being the bank and investing in personal loans isn’t without risk. The most obvious risk is that people will stop making their payments on loans. The average default rate across all loans is 11% or about 1 in every nine loans. The default rate might increase a little when the economy falls but most Lending Club borrowers are in good financial shape. Make sure you have more than 100 loans in your portfolio so a couple of defaults will not affect returns too much.
Lending Club provides you with updated reporting on all your loan investments including how much you have in loans, monthly payments and the payment status of all loans. I can’t stress this enough, you are going to see a few loans stop paying every once in a while. Understand that this is natural in a large portfolio, don’t freak out and you’ll enjoy high returns even after accounting for defaults.
As with all bond and fixed-income investments, high inflation will eat into your returns. While stocks tend to do well when prices increase, the return on your loans will not increase with inflation. Since peer loans pay off within three- or five-years, you really don’t have to worry too much about inflation unless it jumps all at once.
Rising interest rates are a problem for bonds because investors can get higher rates in new investments compared to the same payout in older bonds. It’s the same for peer loans but doesn’t matter if you hold your peer loan investments until they pay off. There is a growing market for selling your peer loans but this is generally a bad idea because you’ll pay a fee to trade and might be tempted to panic-sell your loans if rates increase.
Are Lending Club Investment Returns Falling?
One of the most persistent Lending Club complaints I hear from investors is that returns on p2p loans start out excellent but then start falling. Investors that said they started making double-digit returns on loans in the first year or two are now only making 6% on their investment.
There are two problems here, one real and the other imagined.
The imagined problem is how investors are accounting for their returns on loans. Your return on a new account and new loans is naturally going to be higher. Even a portfolio of loans to high-credit borrowers will have a small percentage of defaults.
But those defaults don’t happen all at once. Most loan defaults happen over the first 18 months of a loan.
The problem here is that investors start out with a portfolio of loans that haven’t reached their max defaults yet. They’re estimating their returns on all loans, including loans that will eventually default. By constantly adding new loans into the portfolio, returns stay fairly high because a percentage of the new loans haven’t defaulted yet either.
But when you stop reinvesting money into new loans, the entire portfolio reaches its “vintage” age where all the loans that are going to default do so. There is that period of time between a new portfolio to one where all the loans are 18-months old that it seems defaults are increasing rapidly and you’re losing money.
If you keep investing in new loans, there will always be some that are defaulting but the rate will slow down as the portfolio ages.
Another problem with Lending Club portfolios is that investors just don’t spend the time to find criteria that limit defaults. I’ve invested for years and across nearly all loan categories but am able to do so with half the rate of loan defaults compared to other investors.
It’s because I’ve taken the time to find those criteria that weed out the bad borrowers. Loan factors like debt-to-income, mortgage owners, and income that lead to fewer defaults and higher returns.
It’s with these criteria that I’m able to get a 9.6% return on a portfolio with an average interest rate of just 11.6% – that’s only 2% of my portfolio defaulting.
Lending Club Investor Reviews
I thought I would pull some Lending Club investor reviews off the internet and from other investors I know. It’s one thing to read my opinion on the p2p investment but it always helps to get perspectives from others.
My cousin has been investing in peer loans for more than nine years. He admits that it was a little rough during the financial crisis but he’s booked 12% annual returns since 2009. He told me that there were several times over the last few years that his stock market investments tumbled like in the beginning of this year but his peer loan investments helped him to keep calm and not panic-sell.
James Turner – Madison, Wisconsin
Joe reached out for a Lending Club investor review and I can’t say enough about peer to peer investing. My wife lost her job last year and it was four months before she found another one. We were able to use the monthly returns on our p2p investments to help pay the bills. I’ve since started putting more money in our Lending Club investing strategies.
Rebecca Siena – Phoenix, Arizona
I have only been investing on Lending Club for two years but am happy with what I’ve seen so far. I invest across different loan categories and use a few of Joe’s peer lending investing criteria for finding peer loans. I hold about 100 loans and reinvest the proceeds every month. It’s a great passive investment and pretty much runs itself.
Lending Club Review Summary
I hope I’ve answered your questions about peer lending investing in this Lending Club review. Feel free to email or use the comment box below if you have any questions. Peer loan investing on sites like Lending Club are just beginning to gain popularity but I think will be an accepted part of everyone’s investing strategy within a few years. The loans pay a fixed amount each month and can help reduce the risk of a complete wealth strategy.
Benefits of Investing on Lending Club
- Safety of bond investments with the higher returns of stocks
- Regular monthly cash return is a great way to plan and pay expenses
- Manageable risks that can help diversify your overall investment portfolio
Drawbacks of Investing on Lending Club
- High defaults in riskier categories may be too volatile for investors that prefer less fluctuations in their investments
- Since peer lending has been around for less than a decade, we really don’t know how loans will react to different economic cycles
- Returns are taxed as income, unless invested in a retirement account
Whether you’re new to investing or just new to peer lending investing, diversify your portfolio with a Lending Club investing strategy for safety and returns. Peer loans offer monthly cash and lower risk compared to stocks. Set your Lending Club account for automated investing to put your investing goals on auto-pilot.