Monday, January 13, 2014

Alternative Investment - Lending Club Peer to Peer Lending

I first heard of Lending Club several years ago during the financial crisis when the loan losses were a bit higher due to the poor economy and falling interest rates. It was a risky investment then because you have customers (borrowers) who are loosing jobs, while interest rates fall - so the rate they are locked in at doesn't seem so attractive anymore.

Interest rates are still at rock bottom levels thanks to the Federal Reserve, and are likely to stay low for a period of time. While I'm no banker, I know the physiology of the borrower. If you are paying on a loan at ... let say 8% and interest start rising - you feel better about paying your loan off than if rates were falling.

As an investor, you can benefit from peer-to-peer lending by supplying portions of the loan (usually in increments of $25) and accruing the interest payments (minus Lending Clubs fee). Essentially you turn yourself into a bank supplying loans. There's a really good blog by a peer-to-peer lending investor that shows his results every month and has a pretty cool website of information you might want to check out to find out more about the industry.

Anyway, during the rise of the equity markets during 2013 I found it hard to put 'new money' to work in markets that were at all-time highs. Consequently I decided to try Lending Club based on interest rates & the general economy had stabilized in the short term.

It's not a complicated website or process to understand, and the website I link to earlier has a wealth of good information, but I wanted to touch on the most important aspect of selecting the loans to invest in on Lending Club.

Filtering:

  • I only purchase loans that have 'Verified Income'
Many of Lending Clubs loans haven't even verified the income of the lender! That sounds like what caused the housing boom/crisis - so I stay away from anything that hasn't been verified. Additionally, I factor in the location the borrower lives. If a borrower makes $10,000/month - that may sound like a lot, and in some parts of the country, it certainly is. However if the borrower is from New York or parts of California, 10k per month might make the loan a little more risky than if they lived in Utah. 
  • Additionally you want to examine the details of the loan application
Things like existing credit lines/usage, if the borrower has delinquencies & inquiries are all things that show up on the credit report. I also like seeing if the lender has entered any notes or answered any questions. I've found loans where the borrower has stated they "have paid off a Lending Club loan before" or they give details of how they are going to pay the loan back each month. These all add to the confidence level of the investment.

Peer to peer lending isn't for anyone. I have recommended this service to other people and they have enjoyed it. While I don't know what their portfolio performance is, mine is around 9% net annualized return and I have no defaults (only after 8 months of lending) so that has me positive about this investment as well. 

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