Before I get to my entry on my strategy and how I screen for loans, I wanted to talk about what Lending Club is not. There can be some misconceptions about it that I feel needs to be cleared up.
Lending Club is NOT usury.
Usury is the practice of giving a loan at immoral interest rates that the borrow cannot afford but is in no position to say no. i.e. payday loans. Going into Lending Club this was something very important to me when I saw loans went up to 25% or more in rates. Am I causing harm to people who are not in a position to say no by placing them into a worse financial situation than they already were? Would I be guilty of causing the same problems that banks did with the financial crisis of 2008? It's not important to many out there, but it is to me.
When we look into what the needs are of borrows we can see that about 75% are either debt consolidation or to pay off credit card debt. Time and again the comment section from the borrow is the same. "I ran up debt in my 20s and didn't know what I was doing. Now I have $30,000 credit card debt. I can make my payments but am not getting ahead. This loan will lower my monthly payment and free up money to start taking control of my financial life."
From that aspect I am doing these guys a favor. They are paying $7,500 a year on their 25% rate $30,000 credit card debt. Their LC loan of 18% is only $5,400. That's freeing up $175 of their monthly pay that they get to keep instead of going to a bank. This is exactly the sort of first step a family would need to turn their financial life around. $175 a month is a great start to an investing account or paying off debt quicker.
You aren't really getting 20%+ yield on your investment.
The other big thing to keep in mind with Lending Club is that you won't end up getting the yield that the loan offers.
First off these aren't qualified dividends taxed at 15% you probably are going to be paying more.
Second, Lending Club is a business and needs to make money. They make that by charging fees. In 2009 I had about a 3.5% fee on average a month though I had been selling notes on the secondary market which does have extra fees then the primary one.
Third is the secondary market mark up fee from the seller. People can charge what they want when selling their notes. If you don't want to play the F5 refresh spam game and try to beat the robot investors to fund a loan on the primary market then you have to buy notes on the secondary market. You can get some good notes with a 2%-4% mark up. That is going to lower your actual return.
The fourth reason you won't be getting the full yield on the loan is you will get less interest is if the person pays off the loan quicker. We get the interest rate of the loan on the existing principal left in the loan. If they pay extra on their loan that is less interest in the future and less profit. I enjoy seeing people get out of debt asap but it does hit your bottom line and is something to keep in mind.
Fifth and probably most importantly, you WILL get defaults. People who stop paying and your money is gone. Lending Club does a good job of following up and trying to make a payment plan with people missing payments but they aren't a collection agency. If the money is gone we are out of money. Defaults rates can be 4% or more.
The long term average for all investors with Lending Club that have 100 notes or more is 8%-9%. The 100 notes requirement is important because at anything fewer you can be really lucky with no defaults or really unlucky with a lot of defaults. Over time however, the law of averages works in the investor's favor.
Lending Club is not a get rich quick 20%+ consistent profit scheme. Its a making money slowly but surely scheme.
Lending Club has restrictions and not all investors are eligible.
As I mentioned in my previous entry, Lending Club has restrictions. Its important to keep in mind these arent Lending Club rules they're federal and state government rules about funding loans. You need to have $70,000 in annual income AND you need $70,000 liquid networth excluding your home. Additionally its only available in 27 states, two of which (KY and CA) have tougher restrictions.
Even with the above concerns and things to keep in mind, I feel Lending Club has a lot to offer and it has a place in my pre-retirement portfolio. Next I'll get into how I screen for loans and my strategy for investing with 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.
Lending Club is NOT usury.
Usury is the practice of giving a loan at immoral interest rates that the borrow cannot afford but is in no position to say no. i.e. payday loans. Going into Lending Club this was something very important to me when I saw loans went up to 25% or more in rates. Am I causing harm to people who are not in a position to say no by placing them into a worse financial situation than they already were? Would I be guilty of causing the same problems that banks did with the financial crisis of 2008? It's not important to many out there, but it is to me.
When we look into what the needs are of borrows we can see that about 75% are either debt consolidation or to pay off credit card debt. Time and again the comment section from the borrow is the same. "I ran up debt in my 20s and didn't know what I was doing. Now I have $30,000 credit card debt. I can make my payments but am not getting ahead. This loan will lower my monthly payment and free up money to start taking control of my financial life."
From that aspect I am doing these guys a favor. They are paying $7,500 a year on their 25% rate $30,000 credit card debt. Their LC loan of 18% is only $5,400. That's freeing up $175 of their monthly pay that they get to keep instead of going to a bank. This is exactly the sort of first step a family would need to turn their financial life around. $175 a month is a great start to an investing account or paying off debt quicker.
You aren't really getting 20%+ yield on your investment.
The other big thing to keep in mind with Lending Club is that you won't end up getting the yield that the loan offers.
First off these aren't qualified dividends taxed at 15% you probably are going to be paying more.
Second, Lending Club is a business and needs to make money. They make that by charging fees. In 2009 I had about a 3.5% fee on average a month though I had been selling notes on the secondary market which does have extra fees then the primary one.
Third is the secondary market mark up fee from the seller. People can charge what they want when selling their notes. If you don't want to play the F5 refresh spam game and try to beat the robot investors to fund a loan on the primary market then you have to buy notes on the secondary market. You can get some good notes with a 2%-4% mark up. That is going to lower your actual return.
The fourth reason you won't be getting the full yield on the loan is you will get less interest is if the person pays off the loan quicker. We get the interest rate of the loan on the existing principal left in the loan. If they pay extra on their loan that is less interest in the future and less profit. I enjoy seeing people get out of debt asap but it does hit your bottom line and is something to keep in mind.
Fifth and probably most importantly, you WILL get defaults. People who stop paying and your money is gone. Lending Club does a good job of following up and trying to make a payment plan with people missing payments but they aren't a collection agency. If the money is gone we are out of money. Defaults rates can be 4% or more.
The long term average for all investors with Lending Club that have 100 notes or more is 8%-9%. The 100 notes requirement is important because at anything fewer you can be really lucky with no defaults or really unlucky with a lot of defaults. Over time however, the law of averages works in the investor's favor.
Lending Club is not a get rich quick 20%+ consistent profit scheme. Its a making money slowly but surely scheme.
Lending Club has restrictions and not all investors are eligible.
As I mentioned in my previous entry, Lending Club has restrictions. Its important to keep in mind these arent Lending Club rules they're federal and state government rules about funding loans. You need to have $70,000 in annual income AND you need $70,000 liquid networth excluding your home. Additionally its only available in 27 states, two of which (KY and CA) have tougher restrictions.
Even with the above concerns and things to keep in mind, I feel Lending Club has a lot to offer and it has a place in my pre-retirement portfolio. Next I'll get into how I screen for loans and my strategy for investing with 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.
Great summary there! The first point is the most important point. No matter how crazy it sounds to put a +20% on a note, we are talking unsecured debt here, and the risk of lending must be accounted for in some manner. As you've said, even with these high rates, the appeal of a fixed rate, generally lower than what currently is being paid tends to benefit the borrowers.
ReplyDeleteAdditionally, I'm curious how you averaged 3.5% in fees back in the day, given that the monthly charge for payments is effectively 1% or less and the cost for selling notes is only 1%.
When you sell notes on the secondary market you are paying an extra fee to LC. I am pretty sure thats what it was but I admit that it was 5 years ago.
DeleteI had 1 note be paid off, 1 went into default and all the rest I sold on the secondary market so I racked up a lot of extra fees that a regular investor will not.
I'm estimating only a 1% - 1.5% fee going forward.
Keep in mind most popular loans are funded in less than 60 seconds (see https://lendingrobot.com/#/lc_popular to get a real time update), so an investor needs to act quickly or automate.
ReplyDeleteThose new loans get funded quickly. Unless a perosn wants to use the LC service to automatically fund loans... there really isn't a reasonable chance of them finding a loan and funding it. The secondary market seems to be the only way to be selective and choosey.
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