Peer-to-peer lending (P2P) is a method of debt financing that has gained popularity in recent years. P2P platforms utilize technology and big data so people can borrow and lend money from one another without using a traditional bank.
Lending Club is the premier peer-to-peer (P2P) lending platform on the market today. With constantly changing financial markets, you're probably wondering, is Lending Club a good investment today? I'm not talking about buying LendingClub the stock, but actually lending on it's platform in this low interest rate environment. There is a search for yield in 2020 as the 10-year bond yield is less than 7%.
Here's a detailed look at the company, its offerings, pros, cons and risk you should take into consideration.
Lending Club is a publicly traded company (NYSE: LC) heavily regulated by the Securities & Exchange Commission. The platform offers various investment and retirement accounts to qualified investors for as little as $1,000. Historical returns have averaged 3–8% per year and an impressive 99% of portfolios with 100+ Notes have seen positive returns.
About Lending Club
Lending Club was founded in San Francisco in 2007 and has facilitated more than $35 billion in loans so far. I've lived in San Francisco since 2001 and have met with their senior management and other personnel multiple times since the financial crisis.
They've had some ups and downs, but managed to survive the downturn. Lending Club has put a lot of effort into growing their lending platform in recent years and pulled ahead of its largest competitor, Prosper, which failed to go public in 2005 and is struggling.
How does Lending Club's P2P process work? The company screens potential borrowers and services the loans, assigning a grade to every approved borrower using credit and income data. The decision to lend money is then ultimately made by one or more investors.
In other words, the loan grade determines what range of interest rates borrowers qualify for and helps investors decide whether or not to fund each loan. Borrowers can’t see their grades; only investors can.
The Lending Club Borrowing Process
Borrowers apply for a Lending Club loan online and must have a FICO score above 660. Over two-thirds of loan applications are rejected by Lending Club, which should provide some comfort to investors.
After the individual borrower is approved, they are then graded, which determines their interest rate. Getting approved does not mean each borrower is default-free. Borrowers with lower grades have a higher risk of default and can default, which is why a higher rate of return is required.
Individual borrowers can apply for a loans starting from $1,000 up to a maximum of $40,000. Rates are competitive when compared to traditional banks and start as low as 5.31% APR. Each borrower's interest rate is fixed for the term of the loan, which are three to five years in duration.The loans are unsecured lines of credit and no different than credit card loans. Also like credit cards, any defaults are reported to the three credit rating agencies (Equifax, TransUnion and Experian).
The platform offers individual loans, small business loans, auto refinances, medical expense loans and more. Investors can choose to lend to the borrowers via notes starting with a $25 per note minimum. For the purpose of this review, I invested only in individual loans and feel the other types of loans are too risky for their rates of return.
Lending Club Rates By Loan Grade
Here are the latest LendingClub base rates for borrowers, and conversely, what you can potentially earn as an investor in the loans. They range from A1 to E5. Lending Club previously offered grades F1 through and G5, but decided to remove them from the platform in 2017 due to an increase in prepayment and delinquency rates on those loans.
The lower the loan grade, the higher the interest rate, thus the higher the potential return for investors. That said, lower grade borrowers have higher default rates, which is why it's important to have a diversified lending portfolio.
Pros and Cons Of Investing With Lending Club
Is Lending Club a good investment for you? Here are some of the main pros and cons for you to take into consideration. Further information follows including some important risks you should be aware of when you open an account.
PROS
Diversification: You don't want to have all your money in one investment and Lending Club makes it easy to diversify your money across multiple notes.
Wide selection: Easily filter and choose investments by loan type, credit score, purpose of loan, etc.
Automated Investing: If you don't have the time or know-how, let Lending Club do the investing for you based on your own parameters.
CONS
Illiquidity – If you want to take your money out, you have to wait until each loan comes due.
Taxed At Ordinary Income – This is the most annoying issue for high income investors. More detail below.
1% Annual Fee — Lending Club charges 1% annually per note you own within the marketplace.
Unsecured Debt — Unlike an auto or home loan, this debt is unsecured. Lending Club cannot collect against an asset if the borrower defaults.
To be frank, P2P lending is at the bottom of my best passive income investments ranking table.
Lending Club Investing Risks
Lending Club loans are not FDIC guaranteed. As you may know, stock investments and real estate investment are not FDIC guaranteed either. The only investments that are guaranteed are CDs or money market accounts up to $250,000 per account holder.
Here are the main risks to investing in P2P lending.
Inflation Risk: Inflation eats into real returns, but it's a risk all investments face. See: Always Calculate The Opportunity Cost Before Making Any Investment
Fee Risk: Current management fee is 1%, but it could go up or down.
Marketplace Risk: Lending Club could go bankrupt, in which case it may take time to get your loans back. But giving LC is a publicly traded company and has a positive operating profit, the chance of going BK is low.
Callable Risk: Loans can be paid off early, which sucks if you have a performing loan. But it's not so bad if you need the liquidity.
Liquidity Risk: You can't access your money until the loan is paid in full. But you can sell your loan on the secondary market, usually at a discount.
Economic Risk: We could go through another financial crisis, where defaults rise. Hence, the important of investing in higher grade borrowers.
Lending Club Investing Strategy
I recommend focusing on higher quality borrowers in the A and B grade. Although you will receive a lower interest payment, the likelihood of getting paid back increases tremendously.
Focus on high quality borrowers who are looking to refinance their credit card debt. Credit card debt often runs in the 15% – 30% range, which is why to such borrowers, paying 6% – 10% is a good deal.
If possible, look for borrowers with a FICO score of at least 680, a debt-to-income ratio of at least 30%, no delinquency history, and positive reviews.
Despite focusing on high quality borrowers, I've still had delinquencies or defaults over the past five years of investing. As a result, it's important to diversify your loans into at LEAST 10 investments if you start out with a small investment. I've spoken to the team, and they recommend an even greater amount. They said with a 100 investment portfolio, you would have still made money during the financial crisis vs. -50% in the S&P 500.
Tax Considerations Of Lending Club Investments
Unfortunately, the investment returns you generate are taxed at your federal and state marginal income tax level. Even if you hold the notes for more than a year, which is the case for most notes, you do not get the l0ng-term capital gains tax rate.
If possible, you are best off choosing a Lending Club self-directed IRA to defer on taxes until exit.
Lending Club Investing Requirements
Lending Club is available to investors in most states except the following: Alaska, New Mexico, North Carolina, Ohio and Pennsylvania. In most states, you must have a gross annual income of $70,000 or more and have a net worth of $70,000 or more. In the state of California, investors must have a gross annual income of $85,000 and a net worth of $85,000. The reality is, nobody really cares or checks. It's an honor system.
If your total net worth is greater than $250,000 ($200,000 in California), there is no annual income requirement. In the state of Kentucky, investors must qualify as an “accredited investor” under the Securities Act of 1933. Finally, you need at least $1,000 to get started.
Ways To Open A Lending Club Account
You can open these types of accounts with Lending Club: Individual, Joint, Traditional IRA, Roth IRA, Simple IRA, Rollover IRA, Trust, Corporate and Custodial.
I recommend investing at least $5,000 to start with so you can get as close to 100 investment loans as possible.
The best way to open up a Lending Club account is through an IRA due to tax deferment. The income you generate from Lending Club is taxed as ordinary income.
To learn more and get started you can open a Lending Club account here as I have done.
Lending Club Investment Conclusion
Investing in peer-to-peer lending is a fine way to diversify your investment portfolio as your wealth grows. P2P lending is one of my key passive income investments.
Since P2P is a form of alternative investments, I recommend keeping your exposure to Lending Club at no more than 20% of your overall investment portfolio. I personally keep my exposure to alternative investments at roughly 10%, which includes real estate crowdfunding, venture debt, and private equity.
It's worth signing up with Lending Club and checking out the platform for free on your own. They've been around since 2007, and I foresee them continuing to grow over time.
It's tough to get a good yield nowadays. Even if Lending Club only provides you a 6% yield on a diversified portfolio, that's much better than 1% or less in bonds.
About the Author: Sam began investing his own money ever since he opened an online brokerage account in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at two of the leading financial service firms in the world. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate.
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