Once in a while I come across an idea that is so brilliant that I lament that I wasn’t the one who had thought it up. When I first heard about “peer to peer lending,” I was a bit intrigued and I did some research. It seems that the two largest companies are the Lending Club and Prosper. After looking at both, I found the Lending Club’s website to be easier to use and their “deal” seemed better. I studied, read their literature and decided to give peer to peer lending a try. After some months enrolled in the program, I have found that the results match the advertisements and I bring the idea to you here so that you might be able to benefit from it. I wish I had found it 5 years ago, I might have retired earlier!
First, let me explain peer to peer lending.
The typical Lending Club borrower is someone with credit card debt who is looking for lower payments. Some credit cards charge 25% and if you have ten or twenty thousand dollars at very high rates, the payments can be crippling. Even if you can make the payments, it is often difficult to pay down the balances. Trying to obtain a second source loan, maybe from your local bank, will likely incur equally high interest rates.
The Lending Club offers loans to qualified borrowers and sets an appropriate interest rate and the borrower applies for a Lending Club loan just like they would for any credit card, revolving charge line or car loan. The Lending Club credit department verifies basic information like credit scores, employment verification and (sometimes) income levels. If the loan is “approved” by the Lending Club credit department, the loan is placed for funding on the company’s website. The website lists loans, not unlike you find products on eBay, and investors (you and I) can purchase these loans.
The Lending Club collects a fee, typically about 1% of the loan and payments to do the credit check and verifications and to process the payments. Having done personal and business loans, I know how much work it can be. They definitely earn their fee and I am happy to pay it!
The biggest problem with investing in loans is that you must often need a LOT of capital. AND, you have a HUGE risk if the loan defaults. If some person is paying 25% on a $20,000 loan, you could loan them $20,000 at 16% and give them a chance to pay their bill down much quicker and save a lot of money in finance charges. But, what if they default? You just lost $20,000. For a large corporation like Visa or Master Card, this is not a problem as they have hundreds of thousands of loans. If their default rate is 10% and they are collecting (on average), 20% in interest, they still clear 10% in finance charges.
And here is the brilliance of the Lending Club. You don’t have to buy the whole $20,000 loan, you can buy a fractional share! The minimum investment in any loan is only $25. With an investment as small as $2500, you can purchase 100 loans. If you average 14% notes that have a expected default rate of 4%, you will (all things considered) average about 9-10% return on your money.
Quick disclaimer: I made my purchase with the Lending Club based on my financials. I am merely explaining how the company works. I cannot say if this type of investment is appropriate for you. Be sure to check with your accountant and/or financial planner and ALWAYS: don’t invest more than you can risk. Also, Lending Club loans are 3 to 5 years. Do not invest money that you will need in less than 3-5 years. This kind of investment is appropriate only for long term investment capital (in my opinion, your IRA or Roth IRA account is a good place to start).
The Lending Club reports that they only “approve” about 10% of the loan applications that they receive. I have attempted to “purchase” loans that were in funding that later failed one or more of the credit verifications (the applicant exaggerated their income or they failed to send in key documents as required to process their loan). It was actually a good feeling when, sometimes, half of the loans that I attempted to purchase were disqualified during underwriting: my money was returned to my account to use to select another loan.
“Dipping my toe in the water,” I decided to fund a Lending Club account with $5,000 from one of my IRA accounts. I opened my account in September and the results have been as advertised. In the top photo, I have made a screen capture of the main page of my account. In it, you can see the annualized rate of return on my portfolio of loans (not including default rate), how much interest I’ve received (in a little over two months), the value of my account (up to $5,150.53 from $5,000 ), the amount of capital that is applied to loans that are being approved, how much accrued interest I have made (but not yet paid), a listing of my loans and if they are current or late, and a summary of the payments I have received to date.
I am sure I will receive some feedback that lending money to unsecured borrowers is dangerous. Really? Visa and Master Card do it every day and make millions. The way to limit risk is diversification: spread your money out and if any one, two, three or four loans go bad, you make up the difference on your loans that pay on time. Think about how much your bank savings account pays you now. .25%? .50%? Maybe if you are lucky, .80% In about 2 1/2 months with Lending Club, I have returned 3% on my money. OVER TIME, the additional 10%, 12% or 16% you earn on an account like this will most likely exceed your loss rates through defaults.
Loans are packaged in A, B, C, D, E, F and G categories. The A paper has the less risk and typically pays about 6%. The Lending Club provides some statistics and I have copied that page below. In the bottom left you can see the expected returns for each of the credit grades, the expected default rate and the overall expected yield. I have primarily purchased B-F paper. Looking at the return after default, I think that the A and G provide the lowest yield to risk ratio. Really, the biggest risk to a portfolio of Lending Club loans is another recession like we had in 2008. I figure, that in a situation like ’08, someone with good credit (A paper) is just as likely to get laid off as someone with mediocre credit (D or E paper). If I can earn a greater yield before the next economic hard times, why not make my money work for me while the economy is doing alright?
After I successfully invested my $5,000, I began receiving payments a little after 30 days. My monthly payments are approximately $150. Of that, $100 is a return of capital (the borrow is paying down the principle of the loan) and $50 in interest. With the $150 I receive in payments each month, I am able to buy bits of 6 more loans at $25 each. In the screen capture below, I segregated my loans into the initial investment and then the monthly accrued interest that is used to purchase additional notes. The monthly payment amount for the initial purchase increases each month as I receive payments on the loans purchased with interest. In this way, my money compounds and continues to work for me. I plan to add an additional $5,000 at the end of the year and perhaps make a larger investment next Spring.
The amount of money you receive in interest can have an ENORMOUS difference on your net worth over time. If you do not already know the “Rule of 72,” you should understand how it works. Take the number 72 and divide by the interest rate and you will know how long until your money will double.If you are getting a 1% return in a savings account, your money will double in 72 years. Most get less, perhaps .5% – so, your money will double every 140 years. Subtract taxes and inflation and you are actually losing money. THE ONLY WAY TO GROW YOUR MONEY is to beat inflation after taxes are taken out.If you pay 30% in taxes, you must earn a MINIMUM of about 6.5% return to beat inflation.If you earn 7%, your money will double every 10 years. At 10%, your money will double every 7 years.Most people make the mistake thinking that 10% is only 3% more than 7%. Over time, this can be a costly mistake.
Lets say you invest $10,000 at 7% and $10,000 at 10% for periods of 20 years.
The 7% money is going to to double twice:
$20,000 year 10
$40,000 year 20
The 10% money is going to do much better:
$20,000 year 7
$40,000 year 14
$80,000 year 21
In almost the same amount of time, gaining only 3% more in interest DOUBLES the amount of money you earn. At 15%, your money will double every 5 years and the results are staggering.
$20,000 year 5
$40,000 year 10
$80,000 year 15
$160,000 year 20
And you wonder why Visa and Master Card make so much money? My point is this: don’t be afraid of investing in (what you may consider) “risky” investments that pay more than your local FDIC bank. Earning .25% return on your money with an inflation rate of 4% means that after taxes, you are losing 4% a year.
Not bad, you think? After 10 years, you’ve lost 40% of your purchasing power. The possibility of a 20%, 30% or even 40% default rate on consumer credit lending doesn’t sound so bad when compared to a guaranteed loss of 40% in a bank savings account? If every 5 or 10 years, you have a small or even moderate loss lending money in an account like this, the years you earned 15% will more than make up for it. You don’t think that Visa and Master Card put their money in FDIC insured banks do you? They are making millions on credit card loans.
What the Lending Club does, it allows you to undercut some of Visa’s business, give the borrower a good break on their interest rate and make a healthy profit for yourself. If a borrower with $10,000 in credit cards at 22% is still a “good risk” for Visa, they should be a GREAT risk for you at 16%!!!
Below is a “typical” loan sheet of a loan that I purchased. You can see the amount borrowed, the loan % rate, the length of the loan, how many payments I’ve received so far, the next scheduled payment and the payment history at the bottom. A great thing about the Lending Club is that the payments are auto-deducted from the borrower’s account. No worry about the customers forgetting to mail their payment, if the money is in the account, it automatically drafts to Lending Club. I will see that the payments due today are “in process” and about 5 days later, my account will be credited with the interest and principle.
Here is a screen capture from the long list of notes that I have purchased. Here you can see the loan number, which “portfolio” I have saved it to, how much I invested, the note credit rating, the interest of the note, the term length of the note (36 months or 60 months), how much is outstanding in principle, the monthly payment I receive for the note, the day of the next scheduled payment and the note status.
And this last page is a typical loan listing from the borrower. This page explains how much is to be borrowed, the amount of payment, the borrower’s income and employment information, why they want the note and all sorts of other information. I like to see a borrower who has been on the job some time and who has a low credit line utilization. With this borrower, they have spent about 57% of their credit card maximum. I don’t like anything about 60% I think that a borrower who is at 95% of their credit line might be using their credit cards for “living expenses.” This gives me feelings of default and I avoid this. You can set your parameters and screen for all sorts of debt, income and employment factors as well as the overall credit worthiness of the borrower (A, B, C paper etc).
I am quite impressed with the professional look and navigation of the Lending Club website.
If you have some long term capital that is inflating away in an FDIC bank, you may consider investing some of your capital towards your goal of someday becoming a millionaire.
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