Investing With Lending Club: Low vs. High Risk Loans

Written by Nickel - 20 Comments

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As I promised last week when I published my initial Lending Club review, I’m going to spend a bit of time walking you through the Lending Club loan selection and funding process. Beyond simply investing in a few loans, however, I decided to spice things up a bit by setting up an experiment to compare the performance of low vs. high risk loans.

As you can see from the screenshot below, I started with an initial balance of $1,000. From this main screen, I simply clicked the “Invest” link to get started.

One of the first things that you’ll notice when you arrive at the investment section of the Lending Club website is that you have two basic options for finding loans in which to invest. You can either browse and select the notes manually, or you can rely on their automated LendingMatch system to find suitable loans for you.

Browsing and selecting loans

Picking out loans manually is actually a pretty interesting process. Over in the right sidebar, there are a number of checkboxes for things like your desired interest rate and the prospective borrower’s credit score, debt-to-income ratio, and delinquency history.

For starters, I filtered it down to borrowers in the highest credit score category with less then 10% DTI and no delinquencies in the past two years. Guess what? I came up empty… I guess people who are completely on top of their finances don’t need to hit up Lending Club for a loan.

I then backed it down to accept those with a 750 or better credit score, but with the same DTI and delinquency requirement. This time around I got eight hits.

This is where it gets interesting… When you click on the loans in the list, you gain access to a ton of information.

For starters, you get loan details including amount requested, the purpose of the loan, the loan grade (A1-G5), interest rate, monthly payment amount, and funding details. You also get to look at the borrower’s (self-reported and thus unverified) profile information, including home ownership status, employer, length of employment, and gross income and a synopsis of their credit history based on info gleaned from their credit report.

Beyond the hard data, the borrower is allowed to write out an expository description of what the loan is for, and you are free to post questions for the borrower to answer. Of course, Lending Club doesn’t verify the description or their answers to your queries, so it’s probably best to take this stuff with a grain of salt.

As interesting as this is, it’s also a bit of a time suck — especially if you’re looking to invest in a reasonable number of loans. The good news is that, as noted above, they also have an automated loan matching platform.

Automated loan selection (and the experiment)

If you’re rather not select your loans manually, you can use LendingMatch instead. As you can see from the screenshot below, all you need to do is enter your desired investment amount and then drag the slider to your desired interest rate (keeping in mind that higher rates correspond to lower quality borrowers).

I started by requesting $500 worth of the lowest risk loans. What I got in return was a portfolio consisting of twenty $25 notes with an average interest rate of 9.82%. As you can see from the screenshot below, these were primarily Grade A notes, with some Grade B mixed in.

Next, I decided that it would be interesting to compare the performance of these more highly rated notes against a riskier selection. As such, I cranked the slider to the other end and wound up investing another $500 in a collection of twenty $25 notes with an average interest rate of 15.42%. In this case, the vast majority were Grade D notes, with some Grade E, F, and G mixed in.

Assuming that Lending Club has priced the risk properly, these two portfolios should perform similarly after you factor in the higher likelihood of default in the ‘high risk’ group. Only time will tell, but I’ll be tracking the performance of the two portfolios and plan on posting periodic updates. Stay tuned!

Mitigating risk

Speaking of risk, another important factor is diversification. The more you spread your money around, the less likely you are to get burned by a particularly irresponsible borrower. The minimum note size allowed by Lending Club is $25, and I took full advantage of this, investing a total of $1,000 in 40 different notes.

Closing thoughts

All in all, I’ve been quite impressed. The Lending Club interface is very intuitive, and they promise great rates. It’s far too early for me to be able to comment on actual investment performance, but I know several very satisfied customers. Hopefully I’ll be joining them.

If you’d like to play along, then by all means…

Published on May 13th, 2009 - 20 Comments
Filed under: Saving & Investing
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About the author: Nickel is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

Comments (scroll down to add your own):

I’ve been with Prosper since August of 2006, with an initial investment of $300. In that time, I’ve made back the $300, and look to (if none of the other loans default) make about $400 in 4 years. Back when I was doing the loans, the minimum investment was $50, meaning that I could only spread my money across 6 loans. Being able to spread the money out in $25 amounts vs. $50 is huge.

I have made 8 total loans from my initial investment, 3 of which were either charged off or filed for bankruptcy, 3 are paid, and two are listed as current.

If I had the same $300 now? I’d probably do what you are doing… Prosper wasn’t a bad experience, it just wasn’t a GREAT experience, but I hope Lending Club proves to be a better deal for you.

The automated loan selection looks like a large improvement, the reduced minimum investment is a plus – it has some things going for it that Prosper didn’t have that I’m sure would have enhanced the experience.

Looking forward to your future updates!
Comment by David — May 13th 2009 @ 8:53 am
Here’s a question for you. I applied for and received a loan from Prosper last year, which I then paid off in full within six months. My primary goal was to show I was good for it. I had a low (around the mid-600s) fico score, too.

After Prosper went into “hiding” I decided to try my hand at Lending Club’s site just a few short weeks ago. I was turned down flat. The first thing I asked myself was, “Why did I even bother to write a brief bio of myself, including having paid off that Prosper loan, if no one was going to give that bio so much as a brief glimpse?”

I knew LC was very persnickety about screening potential borrowers; figuring that my three scores were over 660, I thought it wouldn’t be an issue. I was wrong. I DO have a bankruptcy that was discharged over seven years ago. I will be notifying all three companies to “kindly” remove that from my reports.

The questions is: If I was turned down for a loan, what are the odds I would be turned down for applying to become a lender? Do they look at my financial background or as long as I have the dollars to invest, it won’t be an issue. The reason why I wanted to apply for a loan first is to establish a relationship with LC. Many do this, as it is.

Thanks for your thoughts in advance.
Comment by Jo — May 13th 2009 @ 10:18 am
Jo: Lending Club has very specific minimum criteria for borrowers. From my earlier review (linked in the first sentence of the current article):

“Borrowers must have a credit score of at least 660 based on a credit history spanning at least one year and with at least three accounts listed, two of which must still be open. They can’t have any current delinquencies, recent bankruptcies (past seven years), open tax liens, charge-offs, or collections within the past twelve months.”

I’m guessing that, at the very least, that bankruptcy is still haunting you.

As for signing up as a lender, I doubt there would be any problems. The lender signup process is very quick, so it can’t hurt to try.

Comment by Nickel — May 13th 2009 @ 10:24 am
This is incredible. I love the idea of investing directly in other people. And the fact you get interest on your money makes it a no brainer. I have a bunch of questions though: is there a minimum to start? Can I open an account with $1,000 just to play with it? How many loans can I invest in with that money? What is the expected % of peiple who won’t pay back?
Comment by RonHope — May 13th 2009 @ 4:38 pm
Ron: The minimum to start is $25, which would allow you to invest in a single $25 note. You can invest more into an individual note, or you can buy more notes from different borrowers (or both). The delinquency rate will vary based on how risky the borrower is (higher risk profile = higher expected delinquency rate, but also higher interest rate). The true extent of delinquencies over the life of these notes (three years) is a bit of an unknown, as the company is still quite young.

Comment by Nickel — May 13th 2009 @ 4:42 pm
Hate to be the one to break it to you, but you have no idea of the risk you are taking. Those loan gradings don’t mean anything.

Why? Because the economy is undergoing massive change. The belief that you can measure risk by the “Grade A” is the same belief that created the credit default swap market! No one understood how much risk there was in the credit defaults. Now they know.

I think you have no idea whether someone will pay back a loan because the economy could collapse in the next 6 months. If it does, how many of those “Grade A” loans will default?

Am I saying that Prosper and Lending Club are bad, or that you shouldn’t invest with them? Not at all. I think it’s great that they are creating brand new ways for people to borrow money. I am only suggesting that you may want to consider the risk of massive economic change.
Comment by B7 — May 14th 2009 @ 12:19 am
Please keep us updated on your two “portfolios.” I’m really interested to see how the two extremes turn on. Thanks nickel!
Comment by Eric — May 14th 2009 @ 9:30 am
B7: You are correct. I don’t have a good feel for the risks associated with this sort of thing, nor do I pretend to. That’s exactly why I’m running this experiment.

Comment by Nickel — May 14th 2009 @ 10:09 am
I really like the idea here. I have one question that i don’t think u have yet addressed. How liquid are the loan accounts? If for example, i invest 1000 bucks today and then 40 days from now need to pull out 500 bucks – can this be done (easily and inexpensively)?

Thank you.
Comment by curious — May 17th 2009 @ 10:13 pm
curious: The loans aren’t particularly liquid. They have a 36 month term, and are paid back in monthly installments. As such, you’ll only have 1/36th of the principal (plus whatever interest) back a month from now. It’ll be 18 months before you have $500 in principal back, though you’ll actually have more money by then due to the interest payments. Does that make sense?

Comment by Nickel — May 17th 2009 @ 10:17 pm
curious (#9): You can sell your loans on the secondary market too. So, you could get the 1000 dollars back a day after it was invested. I haven’t tried this yet.

For everyone else that is interested in risks, the A loans are pretty solid: https://www.lendingclub.com/info/statistics.action
Comment by Jeremy Olexa — Jun 3rd 2009 @ 1:21 pm
Hi Nickel,
Would it be possible for you to provide the info that lendng club captures thru 8 pages of borrower registration pages and 4 pages on lender registration pages.. I am a bit skeptic of proceeding. Would it be possible for you provide the screenshots for all those pages??
Comment by Gaurav — Jun 13th 2009 @ 5:59 am
Gaurav: I’ve covered the lender signup in detail here:

http://www.fivecentnickel.com/.....g-process/

I haven’t signed up as a borrower, so I’m afraid I can’t help on that account.

Comment by Nickel — Jun 13th 2009 @ 9:45 am
Thanks Nickel,

Appreciate the prompt response..
Pls do forward the borrower sign up details if you happen to come across anywhere..
Comment by Gaurav — Jun 13th 2009 @ 11:55 am
I really enjoy your blog. I’m especially interested in your Lending Club series. Please keep updating on how that is going. You have inspired me to give it a try as well and your posts help put my experience into perspective. Thanks and keep up the good work!
Comment by Mike — Jul 20th 2009 @ 10:22 am
Has anyone tried selling the loans on the secondary market and if so how did that go?

Nickel, as part of your experiment will you attempt to sell some of your loans on the secondary market?
Comment by curious — Jul 20th 2009 @ 10:49 am
curious: I’ve never tried it, but that’s a great idea. I don’t want to mess with my test portfolios, but maybe I’ll do it with another loan (from re-investment of proceeds) in the future. Thanks for the suggestion.

Comment by Nickel — Jul 20th 2009 @ 11:12 am
My experience is that loans on the secondary market for lending club sell within 48 hours if:
a) the payment history does not have any blemishes
b) the sale price of the loan/note is one half a percent below par
c) the total amount of the note is less than $500.
Comment by Scott Langmack — Jul 21st 2009 @ 1:16 am
I just read one of the comments by a person named B7 above, where he cites great risk and similar uncertanties to the Credit Default Swaps. Hmmmm. I dont think he understands the nature of credit business. For example – the greatest variability in defaults are in the sub-prime borrowers, which Lending Club does not lend to. Amex lost so much money in sub-prime unsecured loans that they got out of the business. The very best credit rated people are solid whether its a recession or depression. As evidence, none, that is ZERO, of lending clubs 680 “A” rated loans have ever defaulted – including 2+ years since they started.
Comment by ScottLangmack — Jul 21st 2009 @ 1:23 am
Does anyone have an idea of how the borrower account summary / details page look like?

While a lender sees his cash account balance and investments categorised by credit grade and current status, does the borrower see these details on his my account page?
Comment by Gaurav — Jul 21st 2009 @ 1:44 am

Type of rates
- CD rates
- Money Market rates
- Savings rates
- Mortgage rates
Money to invest
< $10,000
Term
Up to 1 year
Money to invest
< $10,000
Desired Loan Amount
Loan Type
Refinance Purchase
State

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