Lending Club
February 26th, 2011 at 12:55 pm (Finances, Society)
When your money starts piling up in a savings account with a 0.5% interest rate, you know you need to take action. On a friend’s recommendation, I checked out Lending Club, an organization that facilitates loans between individuals (more information from wikipedia’s article on Lending Club). Rather than paying 29% interest to a credit card company, for example, a borrower can post a request for a $10,000 loan to pay off the credit card at a 15% (or other) rate, and a suite of investors can choose to fund that loan in small increments. Collectively, they provide a loan to the borrower — and they also collectively absorb the risk associated with the loan.
It’s quite an interesting concept. You can review each individual loan in which you might want to invest, which details all of the relevant information about the borrower, including their credit score, a loan risk rating, the interest rate (assigned by Lending Club), the amount of debt they currently have, their credit history, etc. You can then decide how much money to allocate to the low-risk (but lower return) loans versus the high-risk (but potentially higher return) ones. I opted for a conservative mix of mostly lower risk loans, to try it out.
I opened an account with $1000, which is now spread across 40 notes ($25 each). My instinct would have been to make larger investments in fewer loans, but this seems to be the default strategy recommended by the site, so I’ll see how it goes. Browsing the loan options was almost as interesting in a social sense as in a financial one. Each person has their own story and personality associated with their loan request. The vast majority of the loans I saw were for debt (usually credit card) consolidation purposes. (Some people have frighteningly large revolving credit balances, like $50,000!!!???!) Other common loan types were home improvements, wedding expenses, and medical expenses. Some were to pay off an existing Lending Club loan that had a higher interest rate — which seems a smart bootstrapping process; after making some payments, your credit rating may improve and thereby qualify you for a lower rate. I think it definitely makes sense to take advantage of such an opportunity, as a borrower.
For me, as an investor, the cost so far has been my $1000 plus the 30 minutes it took to browse and select 40 loans. The site does offer an automated portfolio builder (given a specified risk level) which provided a starting point, but I was unwilling to blindly accept its choices without at least reviewing them. I replaced some with others that seemed more attractive (or meritorious). The site offers the ability for investors to post questions to the borrowers, which are publicly visible; these conversations were often more useful than the initial description of the loan on the borrower’s part.
After selecting my 40 loans, I was given the following summary:
- Average interest rate: 10.88%
- Expected default: 1.51%
- Service charge: 0.6%
- Projected return: 8.76%
I’ll keep an eye on it to see just how good that projection is!
One other aspect of the account creation process I found interesting was that to open an account you have to certify the following:
I currently reside in one of the following states: CA, CO, CT, DE, FL, GA, HI, ID, IL, KY, LA, ME, MN, MO, MS, MT, NH, NV, NY, RI, SC, SD, UT, VA, WA, WI, WV, or WY;
I have an annual gross income of at least $70,000 ($85,000 if residing in CA) and a net worth (exclusive of home, home furnishings and automobile) of at least $70,000 ($85,000 if residing in CA); or a net worth of at least $250,000(determined with the same exclusions) ($200,000 if residing in CA), OR, if I live in Kentucky, that I am an “Accredited Investor” as determined pursuant to Rule 501(a) of Regulation D under the Securities Act of 1933, AND,
I will not purchase notes in an amount in excess of 10% of my net worth, determined exclusive of my home, home furnishings and automobile and if I live in California and do not satisfy any of the above tests, I will not invest more than $2,500 in Notes.
This makes me wonder what happens if you violate this certification. What if my AGI dropped below $85,000? What if I invested more than 10% of my net worth? What if I moved to Oregon? Would they cancel my account? Reject my money? And where did this kind of “certify that you’re a sensible person” requirement come from? There’s a story there, I’m sure.
Terran said,
February 27, 2011 at 4:27 am
This is quite interesting! It makes a lot of sense — yet another use of the internet to put party A in touch with party B. I am intrigued to see how well your experience works out, and how this site works out in general.
When you think about it, this group is essentially forming a new-style bank, right? The core function of a bank, in some sense, is to put borrowers in touch with lenders. Except that, in a traditional bank, party A never knows who party B is — the bank, as middle-man, masks that information. Conceivably, this model is more market efficient, in some sense, because it does a better job of distributing the information and the risk analysis. Presumably, when you *know* what loans your money is going to support, you’ll make more sensible risk decisions than bank managers, who are not directly vested in the outcome of your money. One wonders if this model, if scaled up, could help prevent the kind of bubble/melt-down we just experienced, due (in part) to elaborate credit default swaps that hide the true risk profile of a particular investment.
On the other hand, we individual investors are not necessarily great risk analysts ourselves. We can probably reason ok about the risk profiles of loans for home improvement or credit consolidation (I’m not sure *I* would be comfortable loaning to someone who has already racked up $50k in credit card balance!). But I, for one, would have a terrible time trying to evaluate the risk associated with something higher end or more complex — an industrial real estate purchase and building construction project, for example, or home purchasing in a market that I don’t know, or a venture capital loan.
It is intriguing to consider what might happen if this kind of direct-transaction model overtook the traditional, broker-mediated transaction model. I wonder if “crowdsourcing” finance would be a net win or a net lose?
With respect to the elaborate certification: I’m not certain where that particular one comes from, but it’s very reminiscent of agreements that you have to sign for various brokerage accounts that support derivatives trading. Those rules, in turn, originate in the SEC, and go back to the big crash that initiated the Great Depression. The point is to prevent lenders from becoming over-leveraged and landing in a position where defaults on their loans will wipe them out. In the case of stock derivatives, the goal is not so much to protect the individual investors (though that’s nice too), but to protect the market as a whole. When enough investors become heavily leveraged, a small triggering event can cause a domino cascade of defaults, which can wipe out huge segments of the market relatively quickly. Which, in some sense, is what just happened with the sub-prime mortgage fiasco…
Glenn said,
February 28, 2011 at 10:06 am
Hi Kiri,
Congrats on blogging about peer to peer lending. You might also consider blogging about Prosper.com. (Full disclosure – I am an employee of Prosper.com) It might be beneficial to your readers to compare and contrast the two sites. Prosper was the first peer to peer site in the US.
In addition, if you would like, contact me personally and I will add you to our list of bloggers we stay in touch with about information about the industry.
Thanks,
Glenn
Daniel said,
March 8, 2011 at 4:51 pm
I had heard of the basic concept, but not any details. Thanks for posting this and good luck with your investments.