Lending Club Review



With interest rates on the floor and markets in turmoil it’s little wonder people are looking for alternative ways of investing their money.

Like any sensible investor you should be looking to diversify your investment portfolio, moving away from volatile markets and looking towards more stable forms of income. That might be property or precious metals.

But there’s another way you might not be aware of, peer to peer lending. What’s that I hear you ask? Well it’s a market place where investors put up the money in the form of loan notes and customers apply for loans; think of it a bit like a community run bank.

This industry has sprung out of nowhere to capitalize on the apathy towards the large banking institutions. They promise large returns for investors and low rates for customers, but are they a reliable long term investment or just a passing fad.

To find out we’re going to take a closer look at the largest and most respected of these companies Lending Club.

 

What is Lending Club?

Lending Club was set up as a viable alternative to banks to provide low interest loans to consumers, which are provided by investors who purchase loan notes with the promise of high returns.

Created in 2007 they’ve provided over $360,000,000 of loans and paid out over $29,000,000 in interest to investors since then.

That headline figure shows a promising return of around 8%, much higher than you could expect from a Certificate of Deposit (CD) or high interest account, but that doesn’t tell the whole story.

Where as CDs and high interest savings accounts incur very little risk, there are significant risks involved in peer to peer lending, the largest been loan defaults. So we’d better take a closer look at how it works and how can minimize your risk.

 

How does it Work?

There are investors and there are customers, investors want a high rate of return, customers want a low rate of interest.

So investors purchase loan notes, loan notes are valued at $25 each and you can buy as many as you wish.

You can then spread your notes across a number of different accounts. Let’s say you have $5000 to invest, you can choose to fund 1 borrower to the tune of $5000 or spread the risk over 200 borrowers for $25 each.

You shouldn’t need me to tell you that the second option is by far the safest. Even if a small number of your borrowers default you should still receive a healthy return on your investment.

 

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Is Lending Club Legit?

This is a valid question, since Lending Club isn’t a bank and the money you invest isn’t covered by any government backed guarantees.

You should realize that all the money you invest is at risk, in the same way it would be if you were trading on margin, your money is susceptible to a margin call.

The risks not only include customers defaulting on loans but also Lending Club stopping administering the service.

But recent SEC fillings show this is a profitable company with strong backers, you can never be 100% sure but it doesn’t look like Lending Club is going anywhere anytime soon.

 

What is the Rate of Default?

This is perhaps the most important question to ask, it’s all very well providing the loans but what if they don’t pay up. If this happens you can more or less kiss your money goodbye.

Fortunately Lending Club are very diligent in vetting potential clients, they’re don’t provide bad credit loans, most of the loans are provided to middle-class families with a substantial income of around $100,000.

Because of this the typical loan default rate has never been higher than 3% since the company was founded in 2007.

Taking our example above, if you spread your loan notes over 200 customers less than 6 of them will default over the period of the loan. That’s a total loss of $150 maximum which is more than covered by the interest paid by the other 194 customers.

 

How Much Money Can I Make?

As with all things financial, the amount you make is related to how much risk you’re prepared to take.

Lending Club grade potential customers from A to G, A being the highest grade and offering the lowest rate of interest and G being the lowest but offering the highest rate, remember even a grade G customer is still way above someone that would be considered high risk by a credit reference agency.

If you’re building a portfolio it’s best to spread your risk across all or most of the grades, if you want to take higher risk then weight your portfolio in favor of grade G notes and vice versa if you want lower risk in your loans portfolio. But what ever you do, don’t stick all your money in grade G notes in the hope of a high return.

As of July 2011 Lending Club loan notes have accrued average Net Annual Returns of 6.04% for A Grade Notes and 12.11% for G Grade Notes. The average return across all grades is around 9.5% per year.

All rates of return quoted by Lending Club are after any defaults have been taken into account. This is a good thing as If this wasn’t the case It’s advertising would be seriously misleading and I would have serious doubts about Lending Clubs credentials.

 

Is Lending Club Right for Me?

Lending Club certainly isn’t right for everyone; the risk involved is on a par with share trading and way above that of a standard savings account or CD. As for whether the return you get is on a par with share trading is down to your skill as a trader.

But if you’re looking for a maintenance free investment that doesn’t require constant looking after then Lending Club could be good choice, you can literally set it and forget it then watch the money roll in. You can even choose to reinvest your returns in new loan notes if you wish.

If you’re going to invest then remember to spread your risk across all loan note grades. I know the rate of return on the higher grades is tempting but it would be suicide to invest 100% of your investment in grade G.




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