Almost two years ago I opened a P2P lending [1] account with Prosper [2]. 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 [3] offered $50 to sign up and I couldn’t resist! So about a year ago I joined Lending Club [3] 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 [3]. 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 [3] strategy.
My Lending Club Strategy
Each time I get paid (twice per month), I transfer $25 to Lending Club [3]. 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 [2] that the single biggest predictor of default was the loan amount. Lending Club [3] 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 [3] 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% [4], 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 [2] 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 [5], make sure to check out this sign-up bonus [6]. 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 [7] to help you handle your taxes on your investments.