I have been using Lending Club since 2009 to try to make the best return on my investment. I have been able to easily beat bank savings accounts, and can often beat the stock market. My current annual return is 11.63%. Here’s how I do it and how you can do it too.
What is Lending Club?
Lending Club is a leading social lending service. The site allows investors to directly lend money to borrowers, circumventing the banking system completely.
Each time you deposit money at a bank, the bank is allowed to lend out a percentage of that money to borrowing businesses and individuals. That is the money that funds mortgages, car loans, new business loans, and other loans.
When the bank makes a new loan, they are accepting a certain level of risk that the borrower may stop paying, also known as default, the loan. To make money, they charge an interest rate to help offset the payment risk.
Lending Club allows you to make that decision as part of a community. You are able to choose borrower applicants from a large pool of potential borrowers and help fund their loan in $25 increments. Think of it like Kickstarter for borrowing money.
Here’s the best part for you. Just like the banks make money from lending their money, you can now make money like a bank. That’s right. You are paid the interest for the loans you invest in, less a small fee.
With Lending Club, you are taking the place of the bank. It is win-win for both borrowers and lenders. Without the middle man to squeeze out profits, they can borrow at sometimes lower rates than the bank, and you can invest for higher returns than bank interest.
How to Sign Up for Lending Club
Joining Lending Club is a quick and easy process. You simply head to the Lending Club website and choose to sign up as an investor. If you choose to sign up as a borrower, you are directed to a loan application.
As an investor, you simply fill out your basic information that you would supply for any investment account. As it is a financial institution, your information is completely safe with Lending Club, just as it is with a stock broker or a bank.
Make sure to supply a correct social security number and contact information, as your investment returns are reported for tax purposes.
How to Deposit Funds into Lending Club
Depositing funds into Lending Club is as easy as setting up a direct deposit. You need two numbers to connect your lending account to your bank account. Transfers are made via automated clearing house transfer.
You need two pieces of information to link your account, and both can be found by contacting your bank or looking at a check.
The first number is your bank’s routing number, the second is your account number. See the check image below for an example.
How to Browse Loans
Lending Club offers an easy way and a hard way to invest. I prefer the hard way, because I have more control over my loans. I don’t trust an algorithm to vet out the best and worst risks for me. Here’s how both work to get you started.
The Easy Way – Lending Club Picks For You
With the auto invest tool, Lending Club creates a portfolio for you based on your criteria. It will only pick loans that match your rules, and you can set criteria and decide how risky you want to be.
You can also get even more control by using the interest rate slider. That allows you to generate a portfolio while choosing a target interest rate. That rate is net of the Lending Club fee and estimated default rate for your chosen risk level.
At the end of the process, you can review your loan selections individually and see a breakdown of your expected return on investment.
If you go this route, ALWAYS look through your loan selections and remove anything that doesn’t add up or pass your gut check. You can also use the criteria that I share with you below.
The Detailed Way – Choose Each Loan Yourself (This is What I Do)
If you really want to pick the best loans, you have to do what the banks do. Scrutinize the loan and the borrower for every loan. I know how it works, I used to work in a bank and was responsible for making new loans.
When you go to “browse notes,” you are first given a listing of every single loan available. On the left sidebar, you can limit down the loans by defining specific criteria. Here’s what each one means and how it works.
Credit Score – This is the borrower’s FICO score. To qualify for Lending Club a borrower must have a credit score of at least 660. I generally pick borrowers with a score of at least 680. I don’t put a ton of weight on credit score because everyone has fair credit or better. To learn more, read my post on what makes up a credit score.
Term – You can choose 36 month or 60 month loans. The five year loans have higher interest rates than the three year loans, but I usually ignore the term and focus more on the borrower qualifications when deciding how to invest.
Interest Rate – This is the first filter I always turn on when I am looking for a new loan. The interest rates are in ranges based on a Lending Club assigned rating. An A rating is lower risk, and has a lower interest rate. A G rated loan is much higher risk, and pays a premium for that risk. I started only investing in A-B rated loans, but as my portfolio has grown and become more diverse, I have added mostly C rated, and some D rated, loans.
Months Since Last Delinquency – Past behavior is the best predictor of the future, and I don’t want to lend to people who are likely to pay late or miss payments. While you do get a portion of the late fee when someone pays late, I would rather be conservative and pick loans where that will not happen. You can filter on 12 or more months, 24 or more months, or 60 or more months. I almost always use 60 or more months as a filter.
Revolving Balance Utilization – Revolving balance utilization is the percent of outstanding credit card lines in use. In general, people with a higher utilization are a higher risk, and I don’t want to give money to someone who is already in debt and not actively trying to fix it. I usually use about 25% as a cutoff, but have gone up to 35% if the intended loan proceeds are paying off existing credit cards.
Review Status – Borrowers go through an approval process. If you select a loan before it is approved, it may still be rejected. In those cases, you just get your funds credited back to your account to pick a new loan.
Verified Income – Borrowers report their income as part of the application process. This is used to calculate the DTI – debt to income – ratio for the loan. Once Lending Club receives a pay stub or tax records, they mark the income level as verified.
Revolving Credit Balance – This category allows you to filter people with high credit card debt. You can filter for less than $100,000, less than $50,000, and less than $15,000. I always filter for people with less than $15,000. I am not going to enable someone with huge credit card debt to have more debt.
Maximum Debt-to-Income Ratio – This filter allows you to weed out borrowers who will have a monthly payment that is a high percent of their monthly income. If someone’s income is 50% going to this loan, they are going to have a tough time paying it. I don’t usually toggle this filter, but I do look at it when vetting the loan on the next step.
How I Choose Loans – Past the Filters
Once I get my list whittled down to those that meet my criteria, I examine each loan one-by-one. This loan was listed toward the end of June, 2013 as an “A3” loan with an interest rate of 7.62%. I added a screenshot below, and will explain what everything means below that.
Loan Listing Summary
At the top, in the listing line, you can see the interest rate, term in months (36 in this example), loan amount, title (entered by borrower), category (picked by borrower), percent funded so far, amount remaining, and number of days remaining in listing.
In the next section, you can see the application date, review status, monthly payment, and loan number. The only really important information here is the payment amount. I always compare that to the income level to determine whether I think the loan will be a real strain on the borrower.
Here you can see the borrower’s monthly income (gross, before taxes and deductions), whether they own or rent their home, where they work and how long they’ve been employed there, and the DTI ratio for the loan. To me, the important parts here are income, length of employment, and home ownership. If someone makes a lot and has been employed by the same employer for many years, they are a lower risk of losing their income. Owning a home is another indicator of a stable borrower.
Borrower Credit History
This is the meat of the borrower’s credit record, and should be given the most scrutiny. Here, you can see the credit score, number of credit lines, balances, inquiries, delinquencies, public records, and derogatory information. I give this section a lot of weight in my decision. We’ve already discussed credit scores and balances, so I’ll skip that here.
The number of credit lines open shows if they have experience with debt. More history here is usually an indication of a more responsible and experienced borrower. If the borrower has only a few credit lines, they are more risky.
Inquiries in the last six months tells you how much new credit the borrower is trying to get. A whole lot of recent inquiries is a bad signal, and I would avoid someone out for lots of new credit. More than 1-2 is a bad sign.
Delinquencies and public records are a no-go for me. Someone with any public records will never get a loan from me, and any delinquencies during the last two years are another elimination point for me. The same goes for any major derogatory marks on their credit report.
Loan Description and Q&A
This is the borrower’s opportunity to explain what the loan is intended for and why you should pick them. Most people don’t put much weight here, but I do. Bad grammar, bad spelling, or an incomplete explanation are reasons I have turned people down. If they don’t take the application seriously enough to do a good job with the description, they might not take it seriously enough to pay me on time.
The Questions and Answers section used to allow for freeform questions, but now lenders are limited to a handful of pre-written questions. This can be a bit helpful, but I don’t spend much time reading the Q&A.
Diversification is Important for Success
Just like with any type of investing, diversifying is very important when trying to control risk and return. If you only have four loans, and one doesn’t pay, you are out 25% right away. If you have 20 loans and one doesn’t pay, you are only out 5%, which can easily be made up by the 19 remaining loans.
The more loans you have, the lower your risk. If you have only a few loans, I would suggest only investing in A-B grade loans. If you have more loans, you can diversify into more C-D grade loans that pay higher interest rates.
Lending Club’s standard account is a regular investment account, and is taxed as such. You can add and withdraw funds at any time, and you are responsible for taxes on any investment gains, just like when you invest in stocks through an individual account.
Lending Club also offers an IRA. The Lending Club no-fee IRA is another great option. Your investments are subject to the annual limits, in aggregate, with any other IRA account you have, but this may be an even better option for some people to diversify outside of the stock market. If you can get consistent 10%+ returns on your investment, and withdraw tax free (Roth) or invest pre-tax (traditional IRA), you are in great shape. Just don’t put all your eggs in one basket, with loans or investment types.
How Much I’ve Made
In my time using Lending Club, I have made 52 investments. Of those, 11 have been fully paid, 39 are issued and current, and 2 are in funding. My account value is $859.20, and I have made $110.33 in interest. My current net annualized return is 11.63%. That’s pretty great, especially when you realize that the compound annual growth rate of the S&P 500 over the last 30 years is about 10%.
I partially have a great return because I’ve never had a loan default. Not once. Even if I do, I am still up in total, and would not worry much because I have so many loans now. I have such a great record of picking loans because I stick to my conservative guidelines. I use what I learned working in a bank when choosing loans, and now you are in on my strategy.
To keep my portfolio growing and diverse, I automatically add $25 to my account each payday. Lending Club has not built the functionality to accept a direct deposit, but it can do an automatic withdrawal via ACH. I set that to match each payday.
Adding enough funds for one loan every two weeks isn’t a big cost to me, and I don’t miss the money, but adding 26 loans per year, or $650 per year in total, can help you build up your investment account quickly.
So what happens when you want out early? There’s an app for that. Okay, not an app, but there is a system and website that can help you sell early into a secondary market.
The note trading platform, run by FOLIOfn, allows you to buy or sell loans before they are due. I have not used the trading platform, so I can’t speak to how well it works. I have heard good stories anecdotally from other finance bloggers, so I would trust it if I need to sell.
If you live in a state where Lending Club is not yet allowed, you may still be able to invest via the secondary market.
Prosper is the main competitor for Lending Club. I do have a small account there, and, like Lending Club, can only give it good reviews. I will skip a long explanation here, because the platform is very similar.
It was a later entrant to the game, after fighting through some legal hurdles, but it is another great product and I have been happy with my experience there as well.
I’ve you’ve made it this far. Congrats! You are now well versed in social lending and know enough to get started and succeed. This link to Lending Club gives me credit for sending you, so if you do choose to give it a try, I would appreciate if you go from my site.
If you have any questions at all about how Lending Club works, let me know in the comments. I’ll be sure to respond so I can help you get started making money!
First image by marubozo / flickr. All others are screenshots from my Lending Club account.