Almost two years ago I opened a P2P lending account with Prosper. I invested in about 20 loans before they shut down for SEC registration. I switched to more stringent lending criteria after having a few loans default early on, but still had many defaults.

Those defaults made me a little turned off by the idea of P2P lending, but then Lending Club offered $50 to sign up and I couldn’t resist! So about a year ago I joined Lending Club and invested in my first two loans. After a few months I was happy with the results and began transferring some of my own money to Lending Club. After several months, I’m averaging about 10.1% on roughly 30 loans – slightly above the average. Here is quick rundown of my Lending Club strategy.

My Lending Club Strategy

Each time I get paid (twice per month), I transfer $25 to Lending Club. That’s enough to fund one loan, and also a small enough amount of money that I don’t mind losing it if the borrower defaults. I also reinvest any payments I receive – I usually receive $25 in payments about every 5 weeks. When choosing my loans, I avoid using the automatic investment option (called Lending Match). Instead, I use the “Filter Notes” option to filter out notes based on these criteria:

  • Amount: I found with Prosper that the single biggest predictor of default was the loan amount. Lending Club allows borrowers to request up to $25,000 – but that amount can mean a monthly payment of up to $800 depending on the interest rate. Most people simply don’t have that kind of money to throw at a loan payment – if they did, they probably wouldn’t need the loan! I filter for loans under $10,000, and usually end up selecting loans of less than $6,000 if available.
  • Interest Rate: Lending Club assigns interest rates based on credit history. I look for A, B, and C borrowers, which correspond to interest rates of 7.94-13.57%. D-G borrowers have higher rates of return but also have higher default risks, so I avoid them. Even C borrowers have to be stellar everywhere else for me to consider them. I usually stick in the B range to get the best risk/reward tradeoff.
  • Delinquencies: I look for borrowers with 0 delinquencies on their record. This substantially decreases the number of loans available for me to choose from, but I also believe it substantially decreases the default risk for the loan I ultimately choose.
  • DTI Ratio: I look for a Debt-to-Income ratio less than 20%, so that I feel absolutely confident in the borrower’s ability to service the loan payments. Technically, borrowers should be able to afford the loan payments as long as their DTI is below 36%, but I’d rather be safe!
  • Funding amount: Finally, I look for loans that are at least 50% funded. I do this for two reasons: so that I know other people thought this was a good investment and so that the loan is made and begins earning interest as quickly as possible.

Browsing Loan Detail

Once the filter has returned a group of loan listings, I take some time to browse each one individually, looking for the following:

  • Type of loan: I usually look for debt consolidation loans or other personal loans – I never invest in loans for small businesses. While I would love to help business owners, I just can’t take the risk without seeing some sort of business plan. In addition, the current economy is not good for new businesses – lots of my original Prosper defaults were business loans. Medical loans also scare me, though I will invest in them periodically if the interest rate is right.
  • Loan description: If there’s no description, I’m not investing. Period. If you want my money, you need to tell me why – in complete sentences with proper grammar and spelling. I think people who really are serious about the loan will take the time to do it right.
  • Questions and Answers: If people have asked questions, I make sure the borrower actually answers them. Getting defensive is a bad sign – it means they’re hiding something. An answer such as “thanks for your concern, I’m trying to do better” is a non-answer. As with the description, I’m looking for proper spelling and grammar.

Choosing My Loan

Once I’ve narrowed down the originally filtered loans even further, I sort by interest rate. I then look for the highest possible interest rate for the lowest amount requested. So if there are two $3,000 loans, and one pays 9% and one pays 8%, I choose the one paying 9%. If there are two loans paying the same interest rate, I choose the one requesting the lower amount. Finally, I add it to my order and submit the order – I’ve just invested $25 more dollars!

Make It Work For You

If you’re interested in investing with Lending Club, make sure to check out this sign-up bonus. Then use “Browse Notes” and “Filter Notes” to select your lending criteria. Once the filter has returned a certain number of results, browse through the listings to check for loan descriptions, questions/answers, and anything else that interests you.

When tax time rolls around, check out our guide to Lending Club taxes to help you handle your taxes on your investments.






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Comments to How to Earn High Returns with Lending Club

  1. That was a sweet article- I’ve never once considered Lending club or prosper. I’ve been more of a casual observer as I’ve heard more and more about them, and even poked around the sites as well. These guidelines are gold!

    Jon

  2. What are the tax consequences of person-to-person lending? I live in the US so I am interested in US tax implications. Do you receive a 1099 or something similar?

    Executioner

  3. Jill,
    I thought this was a great article to get people started. I’ve been investing with Lending Club for almost a year. I’m currently earning an 11.25% return and haven’t had a single charge off, though I have had one late payment. My guess is that yours is a little lower than that. There are still great ways to make riskier investments using many of the techniques you outlined.

    If you are looking for a little bit more risk and potentially a higher return, then you do need to review all the info as you stated. I will generally only invest in higher risk loans if they are for a small amount, like $10k or less. The higher the risk, the lower I like the amount to be. Like you I also screen the reason for the loan. Sometimes people just had a bunch of mistakes early on in their credit history (I know I did once upon a time) and now they are on track but still need assistance.

    I would encourage those who can tolerate it to take the time to look through some of the riskier investments because they can be worth it.

    Executioner, I think any interest you earn is considered interest income and had to be reported. Lending club does provide an end of year statement into your documents section of your account.

    Jenny

  4. I had a different experience with lending club. Took my 25 dollar signup bonus – did one loan – 10k from user with highest rating, loan consolidation. Got about 5 payments before the user went into “bankruptcy mediation”. I assume I will get no more payments.

    25 dollars “invested” 5 dollars returned.

    different results

  5. @Jon Thanks! I wouldn’t put your life savings in or anything like that, but it’s a neat thing to do with some “fun money.”

    @Executioner Yes, you do receive tax papers and must pay income tax. Have to look into whether its considered ordinary income or capital gains – it used to be ordinary income (taxed the same as bank interest) but may have changed with SEC registration.

    @Jenny Thanks for your thoughts. yes, my return is a little lower than yours ,though still above the average that Lending Club reports. I have no doubt that riskier investments can pay off – I just go so burned on Prosper that I never even tried on Lending Club. Maybe I’ll start a new portfolio of higher risk loans and compare performance in several months! Would be a good blog post :)

    @different results I’m sorry for your experience – at least it was free money! your experience definitely underscores the importance of diversification – if you had invested in two loans you would have only lost 50% of your money, in 5 only 20%, etc. You happened to have really bad luck with one loan. P2P lending is definitely not without risk – its an investment, and you can experience losses. thanks for providing a different perspective.

    Jill

  6. Jill, thanks for all the replies! But I have to question your assumption that just because I had a bad loan, my next x loans would work out fine.

    I love the idea of removing the banks as the middlemen, but remember that these are unsecured loans. Reminds me of the old saying “past performance is no guarantee of future earnings”. So it’s possible that 5 out of 5 highly rated borrowers would default and walk away with just a ding against their credit rating. In hind-site, I can guess that my borrower got involved in a bad housing situation, so his ten thousand dollar loan was just a minor pimple on the butt of being massively underwater from a new home purchase.

    In my opinion lending club (or the other P2P companies) should provide lenders with detailed postmortems of failed loans, and factor those details into future borrower ratings.

    different results

  7. I just started in December, got my first payment, and my returns are at 9.23%. I hope to invest more with this in the near future.

    Ian

  8. Is there some place we can get statistics on borrowers and whether or not they successfully repaid a loan? I’d like to build a regression model to look for good lenders, something that kind of codifies the rules you put in your article.

    Thanks for reporting your experience!

    Curious


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