Thursday, February 20, 2014

What is Lending Club

Last month I mentioned that I am returning to Lending Club as an investor and that I would be talking about it in February. I have made a couple deposits, done my research, and picked up some notes so want to share some finding and thoughts.

Essentially, Lending Club is a peer-to-peer money lending service that connects your average person needing money to the average person that has money to lend.
More detailed, a person applies to LC for a loan. They fill in their personal information and LC runs a credit check on them, reviews them, and if they are of prime credit score or higher they will set an interest rate ranging from 4% up to 27%. The requested loan can be in two durations: either 36 months or 60 months.

Now Lending Club does not give them the money themselves. They are merely the middle man. LC then turns the loan over to the community and opens it up to funding. That funding comes from the other users of Lending Club. In as small amount as $25, people can crowdsource the loan. Think of it as Kickstarter but your reward is getting paid back with interest. If there is enough funding to fulfill the requested amount of the loan then the person gets the money and the investor gets a note.. If the loan was for $30,000 and you put in $25 you now own 1/1200th of that loan. It can be held or sold and it will get 1/1200th of the monthly payment of the loan, which ends up being about $0.60 - $0.70.
Lending club takes about $0.01 from a $25 note as a service fee which roughly equates to 1.5% from a $0.65 payment.  This is paid by the investor as it's taken from the loan payment before it gets put into the investor's account.

There are actually two different ways to invest with Lending Club. The above description is their primary market where loans get funded. There is also a secondary market. Once you have your note it is an asset that can be sold to other people. If you have ever played an MMO and dealt with an auction hall then you have a pretty good idea of what this is about.
The secondary market is where I will be investing with Lending Club. I'll get into my specific ideas on strategies in an upcoming entry.

I first encountered LC in 2009 and back then I wasn't impressed but they were new and still trying to figure things out so I left as an investor and figured I would give them some time. Looking at them today they have changed some for the better and some for the worse.

What's better with Lending Club...
They are now more up front about the whole $70,000 income requirement. In 2009 I had to really dig deep to find this rule. Actually, I don't see it discussed very often these days so I will probably bring it up several times. The federal government requires a person to have $70,000 of yearly income to fund loans. That's not a Lending Club rule, that's a Washington D.C. rule. Presumably it's because "the poors" don't know how to calculate the risk of a $25 note and its for their protection. These days though I see it a bit more in the open at LC.
Now the secondary market is a different case. Over the counter secondary markets of selling assets isn't something that Uncle Sam seems to care about and that has no restrictions federally though it might per state. Double check if LC is available for your state.

They now offer tax forms. In 2009 they did not give you tax forms to help with you income taxes. I knew from my dividend investing that payments are income and it gets taxed. I even called LC and talked with one of their reps. I was told that they don't report income unless its $60 from a single source. That being an individual note. I asked about a $600 account limit which is pretty common for 1099-MISC forms. They didn't know anything about that. I then asked what if I had 10,000 notes each giving $0.65/month... that would be $7,800 of payments surely that would be reported. It wasn't and I was told I am on my own to calculate it what portion of the payments is a return of capital and what is actual interest. That was actually the final straw with me and I sold all my notes that week because if they weren't taking taxes seriously what else were they not serious about?

Their portfolio reporting and number crunching is more extensive and more open than before. When I was first with them they didn't offer much in the way of reporting tools for you to evaluate how you are doing. They had a net return but it was vague and involved reinvesting all your money. These days they have a lot of reports and charts to help you figure out how you are doing.

What's worse with Lending Club...
Institutional Investors. Big money has noticed LC and is stepping in. So much so that loans get funded within minutes of being applied. This is bad for a number of reasons. One, there is no question and answer back and forth with the person applying for the loan. In 2009 not all loans get funded and it often took days to get funded. Investors could ask questions like "Why did you have 12 lines of credit closed last year?" or "Why didn't you go to a bank to apply for a car loan instead of using LC for an 18% loan for a motorcycle?" Then the person asking for the loan would need to respond. Institutional investors just put in the criteria of what they want to fund and then dump tons of money into loans. The idea is that it doesn't matter what quality of loan you do as long as you hit volume it would make up for defaults. Yeah talk to pre-2008 banks about that idea. I rarely see any questions in funded loans these days.

This causes a second problem, retail investors have minutes to review and fund a loan before its completed and you miss out. I am reading that some people spam the refresh key at the four times of the day loans are released.
Luckily though the secondary market doesn't have these problems though it has others that I will discuss in my strategy entry.

All in all, I am pleased with how far Lending Club has come along. I like what they are doing, their business model, and the chance to get access to double digit yields. For the time being, I plan to run Lending Club as a side test part of my portfolio until I get 100 notes and can get a feel for default rates and actual return. Its easy for LC to say I will be getting 20% yield... before defaults come into play. I have plenty more to say in the near future about Lending Club.

Disclaimer: The investments and trades discussed are not recommendations for others. I am not a financial planner, financial adviser, accountant, or tax adviser. The financial actions I talk about are for my own portfolio and money and only suited for my own risk tolerance, strategy, and ideas. Copying another person's financial moves can lead to large losses. Each person needs to do their due diligence in researching and planning their own actions in the financial markets.


  1. Looking forward to what else you have to say about Lending Club, but I am very curious as your statement "Its easy for LC to say I will be getting 20% yield... before defaults come into play." Essentially you are saying you can have an average interest rate in excess of 20% or so. I'm not sure what the effect or implication of that statement is ultimately.

    As for the long-term goal of identifying your own default rate, I'd suggest you have an account with 2-300 notes, as this will stabilize your default rates in a much more consistent fashion. At just a 100 notes, you are almost assured a positive return, but statistically cannot make any long-term default rate proclamations based on that small of a sample.

    Best of luck with Round 2 of Lending Club. I can assure you I will be following along! Can't wait to see your criteria for this second go in peer to peer lending.

    1. I meant that you can buy up a bunch of 20% notes and LC will say your return is 20%. A new person can fool themself into thinking they will be getting 20% forever because they haven't had a default yet and seen how much that net annualized return will start dropping.

  2. To state ¨LC will say your return is 20%¨ is inaccurate. Lending Club does not promise 20% as your return at any time. When you invest in a loan, there is an interest rate that the person borrowing the money is obligated to pay. Go to Lending Club's website to see net historical rates of return for Lending Club notes.

    1. I didn't say LC promised me 20% return. I said 20% yield. Huge difference plus if I mention defaults... probably means I'm aware there is no guarantee.