Social lending arbitrage. It’s the newest finance game in town. A reader, Derek, shares the details of how to pull off this fascinating arbitrage strategy. A special thanks to Derek for sharing his story with all of us!
Social Lending Arbitrage Explained
In this instance, I borrowed $10,000 using Lending Club at a relatively cheap rate of 7.78%. I say relatively cheap in that A) it was being offered to me, and B) the price tag in the form of interest was small given the fact that it was actually being offered. This is by no means free money , so your returns will be lower than if it were a no interest credit card  offer, however I’ve noticed those credit card offers have disappeared with the credit crunch we’ve been seeing over the last two years, and bank lending has similarly been affected as well.
That being said, my risk appetite is somewhat greater than the average person’s, and my investments tend to reflect that. I took the $10,000 I borrowed from Lending Club , and put it right back into Lending Club (with a balance also going to Prosper as well), looking for somewhat riskier borrowers than myself. I applied $25 per lending note and spread the total notes by risk class (A, B, C, ratings, etc), taking into account current default rates by risk class to get an estimated return. Looking at all the notes I invested in, I know about 2.5% will default based on current data. But the fact that I diversified my investment into as many notes as possible will (hopefully) minimize my default rate.
A Closer Look at the Numbers
Taking all that into account, my return on investment is close to 15%, with a 2.5% default rate means my net return is close to 12.5%. I pay 7.78% on that capital, and pocket the difference (4.72%), or about $500 over three years.
Yes, this is a lot of work for $500, but not only does it add up quickly, its something that can be built off itself very quickly — the compounding returns only make my returns bigger over time. In my mind, I’m also helping people fulfill their needs by supplying them capital to accomplish their goals. If I can make money and their needs are satisfied, then everybody wins.
I do understand this game isn’t for everyone – I have enough cash in the bank to cover my debt if all my notes default (which has next to no chance of ever happening). But it is free money, and its a very fun 10-minute a week hobby.
More about Derek
I think its good to frame what I do with how I go about doing it. I’m a financial analyst at a growing company (a rarity these days) and because I look at capital flows professionally, over the last few years, I’ve picked up on a few tricks used by companies to grab a decent return on their capital, as well as increasing their capital on-hand for capital buildouts and revenue streams. That being said, I’ve modeled some of those strategies (albeit on a much smaller scale) in my personal life as well. Some with great results, others not so great.
One of those strategies is finding good returns on capital, and having capital offers come your way at a relatively cheap price.
Of course, Derek had me at hello on this one! I’m considering a small scale social lending arbitrage experiment at Lending Club  for some reader enjoyment. However, it might have to wait until our credit card arbitrage strategy is exhausted. Either way, stay tuned for more details on social lending arbitrage!