How to Invest with LendingClub
LendingClub is a peer-to-peer lending site that connects borrowers (them) to lenders/investors (us!). Instead of going to a bank, borrowers can apply for a loan through LendingClub. This loan is reviewed by investors, and can invest with as little as $25. Borrowers like it because they usually get a lower interest rate and lenders/investors like it because they can generate nice returns. However, most investors don’t really know how to invest with LendingClub.
As many of you know, LendingClub is one of my favorite streams of passive income. It is the closest thing to “passive income” I have found. It takes up a miniscule amount of my time and is providing me (June 2013) with a net annualized return (NAR) of over 21%. You can also start with as little as $25 and your portfolio (group of notes) remains relatively liquid (meaning you can sell your investments quickly).
How do you go about picking which notes to buy? In March of 2013 I was making a 12% NAR. Pretty good! However, as the market changed I could find very few notes that matched my criteria. So I had two choices: wait and see if notes that matched my criteria returned, or change my criteria. I chose the latter and things have been better than ever. My NAR has almost doubled and I am going to share exactly how I did it.
LendingClub gives you the tools to filter out notes that don’t meet specific criteria. The following rules make-up the criteria for notes in my profile. I currently invest $25 (one note) a week and re-invest all of my returns (including the interest).
I do not promise that this will work for you and you should consult your financial adviser before making any investment. You should also consider your risk tolerance before investing.
How I Get a 21+% NAR with Lending Club
Rule 1: Invest no more than $25/note (90% of the time).
There is no reason to put all your eggs in one basket. You should be investing in as many notes as possible in order to diversify. Diversifying lowers our overall risk. For example, if you loan $100 to Celine Dion, and she defaults, then you have lost $100. However, if you loan her $25 and she defaults, then you have only lost $25. Meanwhile, the remaining $75 in investments have gone on to provide solid returns.
Occasionally I invest $50/note when the note exceeds my criteria. The note has all the qualities I am looking for and then some! Since I am very risk tolerant, I choose to put a little more money into these types of deals. Notice that I don’t go too crazy and start investing hundreds or thousands of dollars in the note. I will emphasize again that about 90%-100% of your notes should be $25 investments to diversify and decrease risk.
Rule 2: Invest only in
D, E, F, and G loans
If you want higher returns, you have to invest in riskier loans.
D, E, F, and G loans have the highest returns (usually between 20-26%). The default rate will be higher, but the overall return will make up for it. (I have not had anyone default as of yet). I no longer invest in D notes. They are still a great option, I am just greedy, so I try to invest in higher yield notes.
A lot of people are perfectly fine with investing in A, B, and C loans and generating a NAR of 5-8%. I think that is great if you are happy with a 5-8% return! However, each $25 investment is like a little recruitment soldier for your Money Army (#MoneyArmy). Don’t you want him to recruit as many dollars for you as possible? Why recruit 6% when you can recruit 21%? The risk is worth the return.
Rule 3: Invest in borrowers who have a debt-to-income ratio of 25% or less.
Only about 10% of borrowers are approved by LendingClub. This gives investors a layer of protection from borrowers likely to default. However, it is up to us to find the best vehicles for our money. I used this criteria when I first started with LendingClub, and I continue to do so today. From the research I have done there is a noticeable increase in default rates in borrowers with a debt-to-income ration higher than 25%. The lower the ratio the better.
Rule 4: Invest in loans under $20,000.
Originally I only invested in loans under $10k. Because my account keeps making money to reinvest, finding notes is becoming more difficult. I still invest in the lowest loan amount possible (assuming all other criteria is met).
When I increased the loan amount I added additional criteria:
- Rule 4.1: Invest if borrower’s monthly income is five or more times greater than the monthly payment.
- Rule 4.2: Invest if borrower has been employed 3 or more years to the same company. 10+ years is even better.
- Rule 4.3: Invest if the borrower has 0 delinquencies in the last 2 years.
Rules 4.1 and 4.2 I consider once I have my list of loans to choose from. I do not include this criteria in the initial filter. Rule 4.3 I do include in the initial filter. Of course, like all these rules, some may need to be altered to fit your investment goals and risk tolerance.
Rule 5: Only invest in borrowers who are refinancing or consolidating their debt.
I never break this rule. Ever. Borrowers on LendingClub can borrow money for almost anything it seems. I do not want to invest in someone’s college education, a vacation to Hawaii, or the remodeling of a house.
I only invest in borrowers who are refinancing or consolidating their debt because:
- Borrowers are likely to get a lower interest rate through LendingClub.
- Borrowers will have one monthly payment, instead of multiple.
- LendingClub is very strict with repayments and late penalties.
All of these factors, along with the other rules, gives us a good chance at a full repayment.
Rule 6: Don’t invest in borrowers in California.
Sorry, California! You guys have the highest default rate in the country and I want to minimize my risk. Maybe one day I will try you guys out! All other states I invest in.
Rule 7: Don’t invest in re-listed loans.
If you couldn’t get funded and/or LendingClub denied your loan, why would I now take a chance on you? In my book, you get one shot to make it happen.
If you are a LendingClub member, this is what my filter looks like when I search for new loans.
The Rule I no longer follow:
I no longer invest ONLY in loans that are at least 70% funded. I no longer use “percentage of loan amount funded” as criteria. I will invest in a loan that is 0% funded or 99% funded – it doesn’t matter to me.
Originally the thought behind only investing in notes that were at least 70% funded was; “if this many people thought it was a good deal, then it must be!”
I realized that I could spot good loans before they were 70% funded. Dropping this rule exposes me to loans I would have never been exposed to.
These rules are what I use to make my investing decisions with Lendingclub. While they work for me, they may not work for you. Also, time is the only indicator as to the success of my portfolio. I cannot predict how my portfolio will perform in one month, three months, or three years. As our economy changes and people start to earn more or less money, the affects will be realized in my LendingClub account.
LendingClub also includes additional criteria to help you find notes that match your investing criteria. I encourage everyone to explore all possible components to a loan before investing.