A review of Lending Club investing and three strategies for different types of investors
I’ve been surprised how slow investors have been to take up Lending Club investing and peer loans but any new investor asset always faces hurdles. What investors miss by looking at peer lending investing is the huge differences in risk and return on different investing strategies.
I hear investors say all the time that peer loan investing is too risky or too untested. They look at higher defaults during the 2008 crisis and assume all Lending Club investing strategies are created equal.
So what’s the problem in all this?
If you were only to look at penny stocks then you would probably say that stock investing was too risky as well. Stock investing is so much more than just one group of stocks and so is peer loan investing.
In fact, one of the safer Lending Club investing strategies can actually help you reduce risk of losing money during a market crash and still manage returns of above 6% a year.
I’ve earned almost 10% on my Lending Club investments over three years of investing. That’s 10% in cash return, not the paper return you get in stocks and my peer loans are invested in the safest borrowers on the site.
Because I invest in peer loans through an IRA account, I pay no taxes on those gains, and it’s more than double the return I get on other fixed-income investments.
As an equity analyst and advisor of almost 10 years, I can tell you without hesitating that p2p investing is one of the most interesting new asset classes to hit the market in decades.
Let’s look at exactly what peer loan investing is along with returns you can expect on Lending Club and some investing tips and strategies.
- What is peer lending investing?
- Why I invest on Lending Club
- Why p2p investing should be a part of your total wealth strategy
- Different Lending Club investing strategies for every type of investor
What are Peer Loans and Lending Club Investing?
P2P and Lending Club investing is really nothing new. Investors have been putting their money in bank loans for ages. Banks are in the business of making loans, not holding them on the books. They sell their loans to investors that need stable returns.
I can almost guarantee you already own loan investments through any pension fund or insurance policy because these companies are the biggest buyers of loans.
The only difference is that investing in bank loans was only open to wealthy individuals and large institutional investors.
Lending Club and other peer lending sites opens up the investment to everyone. Borrowers for personal loans fill out an application just like any traditional bank loan. Their credit report is checked and the application is verified by the website.
Lending Club then separates the applications into seven risk categories and 35 sub-categories to assign an interest rate on the loan. Investors can browse through loans and decide in which they want to invest.
One of the misconceptions about Lending Club investing is that you are required to invest in all loans. You choose the loans in which you want to invest and can put as little as $25 on any particular loan.
Lending Club offers a great screening tool to help you pick loans on different factors like a borrower’s debt-to-income ratio, home ownership, delinquencies, credit history and more factors from their credit report than you will ever need. It really helps to customize a portfolio of loans on your own risk tolerance and need for return.
In fact, using this screening tool is the way I’ve been able to get higher returns that the average investor on the platform. Lending Club shows the average investor earns around 7.5% on a mix of loans from all those available.
What is hidden in this return is the default rate, the percentage of loans that are not paid off in full by borrowers. The average interest rate charged on loans across Lending Club is closer to 13% but the average default rate of 5.5% means investors only see that 7.5% return.
By using the screener to only pick the best loans, those with the lowest likelihood of default, I’ve been able to boost my annual returns to 10% and keep them there for years.
I’ll reveal the loan filters I use and talk more about this but you can also watch this video where I walk you through the process.
I invest relatively conservatively with almost all my money in the safest three categories of borrowers. I still get an average rate of 11.6% on borrowers with FICO scores above 700 and with below average debt.
Borrowers make monthly payments for up to five years and the platform automatically deposits your portion of the payment into your account each month. You receive interest and principal in each loan payment.
If a borrower stops making payments, Lending Club sends the loan to a collection agency. Typical collection amounts are pretty low but defaults tend to be in the single-digit percentages anyway, especially in the safer categories.
The average borrower on Lending Club has a credit score of 699 and makes $74,414 annually, putting them in the top 10% of U.S. households. That’s helped the platform avoid some of the higher default rates on other peer lending sites.
Lending Club Returns and Peer Lending Investing
Lending Club has helped fund more than $18 billion in loans since 2006 with more than four billion of that just in the last year. I’ve been investing in Lending Club loans for years and love the asset class for stable returns and diversification.
Your return on Lending Club loans comes in monthly which makes it a great source of cash for people living on a fixed-income. Returns on peer lending are going to depend on the loans in which you invest but the percentages across each category are surprisingly stable.
We’ll go into different Lending Club returns you might expect on different strategies but the graphic above serves as a good guide. Returns on the safest categories of loans range from 5% to 7% while higher-risk loans can return as high as 10% annually.
I interviewed one investor that’s been investing in peer loans since 2005 and has made an annualized 12% over the last seven years.
Remember that the average Lending Club returns within each category are for only loans in that category. By combining loans from multiple categories, you can increase your return while smoothing out the risks in the higher-risk loans.
How Do You Invest on Lending Club?
Opening an account on Lending Club takes less than five minutes though it will take a few days to link your bank account and fund your p2p account. You’ll need contact information and your social security for tax purposes but that’s pretty much it.
I recommend opening a retirement account like an IRA, Roth IRA or SEP IRA. Otherwise, you’ll pay taxes every year on the interest you collect. You can still book solid returns after income taxes but why not take advantage of these special retirement accounts and not pay taxes until you retire?
Use your retirement accounts for high-yield investments like peer-to-peer lending and a regular taxable account for long-term investments where capital gains are the biggest share of returns.
Before investing on Lending Club, it helps to understand a little about picking loans. I’ll detail the criteria I use as well as three Lending Club strategies below. Basically though, you are picking loans by selecting criteria about those loans or the borrowers.
By being picky with your loan criteria, you can fine-tune your investments for higher return and higher risk or for lower risk and return.
When you decide to invest, click on Invest in the menu at the top of the page to see available loans. You can invest as little as $25 in any loans that meet your criteria but I like to keep around 200 loans in my portfolio.
That means dividing your total account by 200 for about how much to invest in each loan. That keeps you from having to search for hundreds of loans all the time but makes sure your money is diversified.
Lending Club Investing Strategies for Any Investor
Your Lending Club investing strategy is going to depend on your risk tolerance and need for return on your overall portfolio. Most investors will probably be comfortable putting up to 20% of their portfolio in peer loans as part of their bond asset class investment.
If you’re not sure about your risk tolerance or how to start investing, check out this post on creating a personal investment plan.
The idea is to look at Lending Club loans as a part of your entire wealth, not on a standalone basis. You’re not just investing in Lending Club loans but have a whole portfolio of stocks, bonds, real estate and other assets.
If you were looking at some of the higher-risk peer loan categories in isolation, they may seem way too risky. Look at these same loan categories in the context of a portfolio that holds many different asset classes though and they fit as diversification with a higher return.
Choosing loans in which to invest is extremely easy with Lending Club’s screening tool. You choose your loan criteria and the screen populates with available loans. This helps to create an investment strategy customized to your own needs.
Super-safe Lending Club Investment Strategy
While some investors prefer to invest in the riskier loan categories for a higher return, there are a lot of investors that use Lending Club as a part of their relatively-safe bond investing portion of a portfolio. Loans are debt obligations on a borrower’s credit so must be paid off unless the person wants to destroy their credit score.
Borrowers in the top two or three rating categories have excellent credit scores, well above 700 FICO and make more than $80,000 annually. Combined with a few of the criteria below, these aren’t the kind of people that are going to ruin their credit on a small $5,000 loan.
For solid returns at lower default rates, I use the factors below for a safe Lending Club investment strategy.
- Loans from A, B or C
- Home Ownership
- Income Verified
- No accounts delinquent
- No charge-offs in the last 12-months
- Debt-to-Income of less than 30%
The return on loans with these factors has generally been around 6.5% annually, well above the return on investment-grade corporate bonds and even above corporate high-yield debt.
A Lending Club Investing Strategy for Higher Returns
Investing in peer loans can still be fairly safe, even on investing strategies for higher returns. The most important idea is that you diversify across many loans and use a few criteria to weed out the lower quality loans.
I wouldn’t recommend chasing very high returns for most investors but if you can stomach higher defaults then you can make a great return on higher-risk loans. Understand that while default rates are higher in the risky loan categories, rates are higher and your return will even out on a portfolio of 100+ loans.
Consider some of these factors for a high return Lending Club investment strategy:
- Within loan grades D/E, all 60-month loans and no delinquencies
- Within loan grades F/G, only 36-month loans, no delinquencies, DTI < 30% and no credit inquiries in last six months
Limiting the loans you buy within the higher-risk categories will help lower defaults but you’re still going to see some loans go into non-payment. It’s just a reality of peer loan investing. You should still be able to book an annual return of around 12% on your portfolio of loans.
My Lending Club Investment Strategy
My own Lending Club investment strategy is on the higher-risk side. I have several decades to retirement and can tolerate a little higher risk for better returns. I usually maintain between 10% to 15% of my wealth in peer loans and use automatic investing to keep fully invested.
The loan factors I use for my Lending Club investment strategy are:
- Loan grades C, D, and E
- Invested roughly equally in 36-month and 60-month loans
- No delinquencies
- No credit inquiries in last six months
I like the middle-loan grades as a trade-off between risk and return. Investing across 36-month and 60-month loans spreads the risk out further and helps to increase monthly payments compared to a portfolio of only 60-month loans. Surprisingly, you can still see returns of around 11% on an investing strategy that goes after a middle-of-the-road approach.
How to Use Lending Club for Monthly Cash Flow
I’ve heard people say that Lending Club and p2p investing is too risky for retirees or older investors.
Bull*&$t! Only one-in-five Americans has a credit score above 700 FICO, and that’s just the average score for Lending Club borrowers. An average household income of nearly $75,000? These are solid borrowers that repay their loans and don’t want to destroy excellent credit scores.
I say Lending Club can be a great investment for anyone that needs monthly cash flow for living expenses. Loans pay principal and interest every month. I make over $600 a month even on a small portfolio of $20,000 in peer loans.
Granted, that’s principal and interest so you should be reinvesting some of that money to create constant cash flow but no other investment provides the kind of cash as peer loans.
The average retirement savings of $140,000 invested in a stock and bond portfolio will provide just $5,600 a year without fear of running out. Put that money in peer lending and you can safely withdraw nearly double that every year and not run out for more than 30 years!
Investing in peer loans is no different than investing in corporate bonds, something recommended by all financial advisors. The only difference is the credit quality of borrowers. I’ve seen retirees throw money at junk-bonds of nearly bankrupt companies, stretching for a higher yield but then say p2p investing is too dangerous.
Do you need to be careful about the loans you pick on Lending Club? Sure but no more than you need to be selective about the bonds you buy for the rest of your portfolio.
Use a smart loan filter to invest in loans with less likelihood of default and match the risk categories with your needs. It’s that simple!
Is Lending Club Passive Income
One of the best features on Lending Club is the automatic investing tool, something like robo-investing for peer loans. You customize the screener for the types of loans in which you want to invest and Lending Club will automatically invest the money in your account each month.
You receive interest and principal payments each month, money that isn’t going to be earning a return until you reinvest it. That makes cash sitting in your account one of the biggest drawbacks to p2p investing.
Lending Club doesn’t charge a commission when you invest so you won’t see fees eat away at your return like in stock investing. A 1% payment fee is deducted from each loan payment that comes in. This means you don’t pay a fee on defaulted loans.
Even if you want to invest in individual loans on your own, I would recommend letting the automatic investing tool pick some loans each month. One of the Lending Club invest tips below is to stay fully invested because money in your account isn’t generating profits otherwise.
You may have to tweak your investing criteria a little to stay fully invested, depending on loan availability. Still, the automatic tool on Lending Club makes it about as close to passive income as you’ll see in most asset classes.
Lending Club Investing Tips
So we’ve already talked about staying fully-invested in loans through the robo-investing tool. Money sitting in your account isn’t generating a return and there’s really no reason to hold cash.
You also want to strike a balance between risk and return in your Lending Club portfolio. Don’t go after loans in the highest-risk categories thinking you will get rich quick. The default rate on these loans is going to be higher even with using a few criteria to boost quality and your returns are going to be fairly close to the average.
Understand your risk tolerance as an investor and invest across a diversified portfolio of loans. You’ll see higher average returns and won’t freak out when some loans start defaulting.
One of the best Lending Club investing tips is just to invest in a large amount of loans. I would recommend at least 100 loans but you really want to hold 150 loans or more. Take a look at the chart below provided by Lending Club.
Investing in less than 100 loans means just a few defaults could seriously impact your returns. You might get lucky and have very few defaults and a higher return…or you might see below-average returns. Invest in upwards of 200 loans and even the unluckiest 10% of investors see returns pretty close to the median investor.
An absolute must for Lending Club investing is to do it through an individual retirement account (IRA). Since the interest payments you receive on peer loans is taxed as income, you’ll be paying taxes at your income rate each year. That can seriously limit your returns, especially for investors in the higher tax brackets. Investing through an IRA on Lending Club means your returns grow tax-free until retirement.
Lending Club Investor Reviews
I’ve been investing on Lending Club for only a few years now and have few complaints. I like the automated investing feature that puts my money to work regularly and the returns have been much better than I could expect from other types of bonds.
I wanted to get some feedback from other Lending Club investors and what they thought of the new asset class.
My cousin Jeff has continued to invest in Lending Club loans, putting more than $10,000 in the account and doubling his money since 2005. His investing strategy has changed over the years and he recommends new investors start with strict criteria for loans. That will help limit defaults and keep you from being disappointed before returns start averaging out.
Another reader of my personal finance blog, Jim Palinski, has been investing on Lending Club for three years now. Jim started investing by spending hours screening through loans and checking his account daily. He ended up getting burned out and missed out on some returns because he didn’t check the site for three months. He recommends that investors relax and just set their Lending Club account on auto-pilot with automatic investing.
I have gotten complaints about Lending Club from investors. Sometimes it can be difficult to find loans that meet your criteria if you are limiting the loans you buy. Institutional investors have poured into p2p investing because they can’t get the same returns in bonds. Competition is high for the best loans which makes the automatic investing tool even more necessary.
Another reader complained about the change in borrower-investor interaction over the past few years. It used to be that investors could ask borrowers questions before they invested in a loan. Investors still have a list of questions they can ask but don’t directly contact borrowers. In my opinion, it makes the process easier for borrowers but I can see why some investors would want more interaction.
Is Lending Club a Good Idea?
I’ll admit, I’ve been investing on Lending Club for years so maybe I’m a little biased. It’s a revolutionary new asset class with the potential returns of stocks and the safety of bonds.
Will people lose money investing in peer lending? Yes. There are investors that only invest in the riskiest loans. Those loans will be the first to go bad when the economy hits a recession.
Invest in safer loan categories and pick your criteria wisely and you’ll make money even in the roughest of times. That’s not to say that someone with a $75,000 income and a 750 credit score can’t default on their debt but it’s much less likely.
Put a portfolio of 200 of these solid loans together and you’ve got a portfolio that will produce 7% to 9% annual returns even in a recession.
More importantly, investing on Lending Club smooths out your returns from a stock and bond portfolio. P2P doesn’t follow the same characteristics as stocks, bonds or even real estate so you don’t have to worry about all your investments taking a tumble at the same time.
Lending Club Investor Summary
I haven’t covered everything in this Lending Club investment review but feel free to ask any questions in the comment section. I think p2p loans are one of the most neglected asset classes among investors and a great opportunity to diversify your portfolio.
Pros of Investing on Lending Club
- Higher returns than bonds and risk factors that do not correlate with stocks means strong diversification in a portfolio
- Low investment fee of 1% and can stay fully invested without paying more fees
- About as close to passive investment as it gets with the automatic investing tool
Lending Club Investing Complaints
- Less interaction with borrowers than in the earlier days of the Lending Club platform
- Your investment is locked-up for the life of the loan, either three- or five-years.
There are other p2p platforms but Lending Club investing offers the largest selection of loans and some great features to customize your investing strategy. There are drawbacks to investing on Lending Club just as there are to stock investing but the asset class offers a great opportunity to smooth risk in a stock and bond portfolio. Customize your Lending Club investment strategy according to your investing plan and take advantage of the automatic investing tool.