Investing With Lending Club: Six Secrets to Higher Yields

By Staff

I have been investing money at Lending Club for over a year now, so it seemed like a good time to review my progress. While I started small, I have been adding a small amount to my modest portfolio each month. I’ve been lucky to this point; none of my loans have charged off. Here is an overview of my strategy for identifying profitable, relatively safe loans to invest in.

First, a little background for those unfamiliar with Lending Club, directly from their website:

Lending Club is an online financial community that brings together creditworthy borrowers and savvy investors so that both can benefit financially. We replace the high cost and complexity of bank lending with a faster, smarter way to borrow and invest.

Couldn’t have said it better myself. Basically, this is how the process works. Borrowers apply for loans to consolidate debt, start businesses, make home improvements, etc. Their loan requests are made available to investors (people who have signed up as an “investor” and are looking to loan money to borrowers).

If enough investors agree to cover a portion of the loan up to the requested amount, and borrowers agree to terms with Lending Club, the loan is approved and borrowers begin making payments. Each month, a portion of your original investment is repaid, including a bit of interest (minus a small service fee).

Eventually, if the loan is fully repaid you will receive back your initial investment plus interest, an investment that generally yields far more than traditional savings accounts pay. How much more? Well, that depends on the types of loans you invest in.

Borrowers are “graded” by Lending Club based on their creditworthiness, considering a variety of factors. In addition to this grading system, loan listings provide you with a credit score range, credit utilization ratio, debt-to-income ratio, and a variety of other metrics to help make an informed decision. Generally, the riskier the loan, the lower the grade and higher the interest rate.

Most listings also include a discussion thread Q&A between potential borrowers and potential investors interested in learning more about their employment status, intentions for the money borrowed, etc.

At the time of this writing, my net annualized return is running 11.04%. Most of my investments have been in grade A or B loans that meet a set of criteria I’ve developed over the last few months in an effort to avoid charge off (yes, you can lose your money) while maximizing returns.

My Six Secrets for Earning More With Lending Club

1. Invest in loans less than $9,900. Lending Club allows borrowers to borrow up to $25,000, but for me, that’s a lot of burden for someone to take on (even if my portion of the loan is only $25). Requests for an even $10,000 seem fishy to me, too, so I like to invest in amounts less than $9,900. Under this threshold, chances are borrowers are requesting a specific amount for a specific purpose., making it more likely that they will repay.

2. Look for borrowers with debt-to-income ratios less than 15%. The lower the debt-to-income ratio, the higher the chances they will have money freed up for making payments on your loan.

3. Funding progress is at least 70%. If seven out of ten investors were willing to invest, and other criteria has been met, chances are I’ll invest, too.

4. Invest only $25 per note. $25 is the minimum amount allowed by Lending Club, and after experimenting with various amounts, I’ve decided to stick with the minimum amount for maximum diversification. I’d rather have four loans at $25 each than one with $100 exposed.

When I spoke to Rob Garcia, Lending Club’s Sr Director of Product Strategy, he stressed the importance of diversification when investing in Lending Club loans: “Diversification can lead to more steady returns while lowering your risk.  For example, 98.4% of Lending Club investors with 100 Notes or more have experienced positive returns.” See Distribution of Investor Returns

5. Look for borrowers with zero delinquencies…ever. I understand people can change, and past troubles are not necessarily indicative of future troubles. However, I’m investing my money here and I am not into giving second chances through investments. If I want to help someone get a second chance, I’m more inclined to give instead of loan.

6. Do not invest more than 10% of your taxable portfolio in social lending. I’ve been lucky so far earning over 11% and not losing any investment money to charge offs. However, it is possible, so I do not recommend loading up on peer-to-peer loans to chase a big return. As with any risky investment (and I consider anything over savings accounts to be fairly risky these days), I would limit my contributions to 10% of my overall, non-retirement portfolio.

Note: I recommend creating a filter while browsing notes for criteria 1-5. The post How to Earn High Returns with Lending Club inspired this strategy.

A Word About the Ethics of Social Lending

I initially tried Lending Club as an experiment, and before deciding to invest more money I thought long and hard about the ethics of lending money to others. I haven’t forgotten what it’s like to be in debt – after all, I only became debt free in the last year.

I worried that, in a way, I was simply enabling people to borrow money, so I limit myself to those borrowing for consolidation purposes, rather than taking on a project that needs financing. I suppose borrowing is borrowing, but I’d like to think those borrowing to consolidate debt are also interested in eventually paying off that same debt – more so than someone looking to borrow $15k to remodel a kitchen, for instance.

I’m also hopeful that borrowers are obtaining a better interest rate from Lending Club than they were paying to banks and credit card companies. When I was in debt I remember credit card issuers jacking up my interest rates for no apparent reason other than “the economy is bad.”

I suppose in this way, I am making borrowers’ paths to debt freedom a little bit easier. And of course, I like the idea of cutting out big banks and lending directly to borrowers.

In the end, I decided I would invest a small amount with Lending Club, but do so rather selectively in borrowers whose story and financial picture made me believe they would successfully pay off their loan.