As the first post on this blog, I would like to provide a brief overview of exactly what LendingClub is and how it works. Lendingclub.com is a platform for "peer-to-peer lending" which means it pairs investors with individuals who need loans. The main advantage of this method of lending is that it allows the actual investors to receive the high interest rates of personal loans rather than banks who traditionally underwrite these types of loans.
First, I will explain the way LendingClub works. Borrowers who are looking for loans of up to $35,000 fill out an application with the details of their employment history, salary and intended use of the loan proceeds. Additionally, they consent to a credit check. Finally, they choose whether they would like to repay the loan in 36 or 60 equal monthly installments. Then LendingClub uses a formula based on the borrower's credit history to assign a credit "grade" and interest rate to each borrower. Interest rates currently range from around 5.5% all the way up to 24.5%. All of this information is compiled into application summaries which are posted on the lending platform. Then investors browse through the summaries to find attractive investment opportunities. One of the great things about lending club is that once an investor decides to invest in a specific loan they can then decide how much they want to invest. This amount can vary between loans to limit exposure to more risky investments and increase exposure to relatively safer loans. You can choose to invest any amount you would like in each loan in multiples of $25. The minimum investment in any given loan is $25 and the maximum investment is the entire value of the loan.
Due to the risky nature of the personal loan business, LendingClub has developed incredibly strict criteria for borrowers to be approved to take out a loan. They reject over 90% of all applicants based on their credit reports. This means that, while the loans are still considered speculative and very risky, the borrowers are reasonably qualified to take out a loan. Since its inception in May 2007 the average return across all loans on the platform has been 9.64%. This means that if you invested in all of the loans ever issued, even taking into account defaults and fees, you would have earned an annualized return of 9.64%. However, the 9.64% annualized return includes many loans that are less risky and only pay 5-10% per year. By selectively choosing only the higher yielding loans it is possible to earn significantly better returns. For example, if you invested in all of the "G" category loans (which is the riskiest rating category and thus the highest yielding group of loans) you would have earned a 14.49% annualized return since the inception of LendingClub. Additionally, a relatively new statistic released by the site shows that 100% of lenders who have invested in more than 800 notes have had positive returns on their investment. Nobody who has invested in over 800 notes has lost money.
In order to maintain the platform and screen loan applicants LendingClub charges a service fee of 1% of all monthly payments that you receive. This fee is well worth the service and does not make a significant impact on your returns. LendingClub states that the service fee reduces returns by 0.71% on 36-month loans and only 0.45% for 60-month loans. I will explain the math behind these numbers in a later post.
Overall, I think LendingClub is by far the best investment opportunity available to the relatively young investor who is just starting out. One reason is that the low minimum ($25 per loan) allows you to diversify across many different loans. This means that all of your eggs will not be in one basket even if you don't have a lot of capital to invest. Also, investing in LendingClub is as time intensive as you want it to be. If you are busy you can set automatic investment plans which simply invest in notes that meet your criteria automatically which doesn't require any monitoring or time commitment. Even with this type of system you can expect average returns of 9.64% which is significantly better than most passive investments. Or, if you would like to take an active management role in your portfolio, you can be more involved and read through every loan description before making a decision. This could potentially improve your returns if you are able to spot loans that are more likely to default and avoid investing in them.
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