Choosing the Best Notes
Optimizing the performance of your Lending Club account
Many of you are familiar with LendingClub.com and the benefits it can provide as an asset in your investment portfolio. For those of you who do not know what Lending Club is, Lending Club is a peer-to-peer lending website that connects borrowers with investors. For the purpose of this article I will be discussing the investor side of Lending Club and ways to generate the highest possible return.
If you have an investor account with LendingClub.com then you know that each note can be invested in for as little as $25. This allows us to minimize our risk by diversifying across as many loans as possible.
Rule #1: Only invest $25/note.
There is no reason to put all your eggs in one basket. You should be investing in as many notes as possible. For example, if you loan $100 to Mrs. Fields, and she defaults, then you have lost $100. However, if you loan her $25 and she defaults, but your other three loans of $25 are fully paid back, then you are in a much better position. Sure, Mrs. Fields could never default, but why take the additional risk if you don't have to?
How do we choose which loans to invest in?
Everyone will have a different answer to this, and as always, you must invest based on your own goals and risk tolerance.
Rule #2: Only invest in D, E, F and G loans.
Yes, these loans are riskier (with interest rates between 18%-25%), but the odds of higher returns (in my opinion) are worth it. Afterall, it is only $25, and because we are able to diversify across so many loans, I am willing to take the extra risk for the higher return. Your default rate will likely be higher, but you should make up for it in the higher interest rates and return on investment. The A, B, and C graded loans do not offer an interest rate (usually 6%-15%) that is attractive enough for me to invest. If I am going to put my money to work, I want the overall returns to be as high as possible. The keyword here being, overall. You must understand that you will almost certainly have a higher default rate than if you just invested in A, B, and C graded loans.
Rule #3: Invest in borrowers who have a debt-to-income ratio of 25% or less.
Even though only 10% of applicants are actually approved to become borrowers with Lending Club, I still aim to find the best possible borrowers. Why 25%? Why not 30% or 35%? From the research I have done, after 25% you see a dramatic increase in defaults on loans. That's why I have made it a point to only loan to borrowers with a debt-to-income ration of less than 25%.
Rule#4: Invest in loans with a total value of $10,000 or less.
There are some exceptions to this rule. One exception would be if the borrower's monthly income is exponentially higher than the minimum monthly payment on the loan. For instance, if a borrower earns $5,000 per month and their loan payment is only $200 per month, that could be a smart investment.
I also consider the time the borrower has been employed with the same company. If it is over ten years, I am more likely to invest in a loan over $10,000.
For the most part, investing in loans less than $10,000 substantially decreases the likelihood of the borrower defaulting. A three to five year loan at a competitive interest rate makes the payments small enough that the odds of the borrower defaulting are very low.
Rule #5: Invest in loans that are already 70% funded or more.
My explanation for this is simple: if so many people are willing to invest their money in a certain borrower, it could be a smart investment. Of course, this type of mentality can get you in to trouble. You do not always want to be a follower. You should verify that a loan meets your other criteria first before considering the "70% rule."
Rule #6: Only invest in people refinancing credit cards or consolidating debt.
This is the rule I never break. I personally don't have the risk tolerance to fund someone's business start-up or a family's vacation to Italy, for example. I like people who are consolidating their debt because it allows them to make one simple payment at a lower interest rate than their previous creditor(s) would provide. If all other criteria is met, I am confident they can make their payments.
Most businesses fail, and lending money to the Johnson family for a vacation is no way to invest money, in my opinion.
Rule #7: Don't loan to borrowers in California.
Why? California has a very high default rate. So I limit my risk by avoiding borrowers from this state. All other states get the green light from me.
There are many other items to consider when choosing which notes earn your investment. What about their credit score? Delinquencies? Public records? Open credit lines? 36 month or 60 month loans? All of these questions play a factor in determining someone's ability to repay their loan and should be considered. When confronted with an overwhelming amount of information, I like to narrow the playing field with these 7 "rules" or factors. Then I can more closely examine the remaining options by asking the borrower questions, etc.
Remember, the goal is to invest in loans with the best chance of providing the largest return.
By following these rules, I have and will hopefully continue to earn a more than 12% return on my money -- all of which I reinvest into more loans. Best of luck on your financial journey!