How to Evaluate a Lending Club Loan
I have been using Lending Club to build a small alternative investment portfolio since early 2009. One of the reasons that I got into peer-to-peer lending, though I have initially resisted the idea, is that the returns I got from savings account were just too low. In the past two years since I started, I have gradually built up my portfolio to 350 loans with a total value of nearly $6,000. It’s still quite small comparing to what we have in the stock market, but quite large in my view given the risk involved in p2p lending.
After two years with Lending Club, I found myself becoming more and more conservative in selecting which loans to fund. It’s not an attempt to diversify because I don’t think you can really diversify Lending Club loans. Rather, it’s more careful with loan selection. At the beginning, I mostly went after low Grade C & D loans because I wanted to have a better return. That, however, led to a bunch of defaults and charge offs since last summer that severely lowered my return (I currently have 13 defaults). Now, I look for Grad A and B loans most of the time. Though a direct result of being more selective is, again, that the expected return is reduced, I hope it can eventually improve the investment performance. But that’s not guaranteed because there is just so much information you can use to scrutinize a borrower and while everything looks fine on paper, lot of unexpected event could happen and the next thing you know, the borrower passed away, lost the job, or filed for bankruptcy, and the loan defaulted. Those all happened to me at some points.
Anyway, I am trying to explain in the following what I look when evaluating a loan list on Lending Club for those who are interested but are yet in peer-to-peer lending and hopefully get some feedback from others who also invest with Lending Club.
For every listed loan, the details are divided into six parts, including Loan Details, Borrower’s Profile, Borrower’s Credit History, Loan Description, Borrower’s Affiliations, and Questions & Answers. Each part carries some information that can help me determine whether I want to lend my money to the borrower or not.
Loan details give me a quick summary of the loan I am interested in. In addition to loan amount, purpose, monthly payment, grade and rate, and status, I also pay close attention to the percentage of funding received and the total number of lenders committed to the loan since the date the request is submitted. The reason is clear: Since I am not the only one lending money to the borrower (if it’s a large loan, there will be a lot of lenders to fund the loan), I want to get a sense how other people feel about the borrower. Every lender evaluates the loan independently using his/her own criteria and priorities. If a large number of people signed up to fund the loan in a short period of time since it was listed, then there’s a consensus on the trustworthiness of the borrower. And that could make me feel a little bit comfortable about lending the money to the borrower as well. If, on the other hand, a long time has past and the loan is still not fully funded, then I will be cautious too.
The size of the loan, in addition to its purpose, also plays a role, quite an important one actually. Now I generally avoid loans that are $15,000 or more.
The borrower’s profile tells me the borrower’s employment, homeownership, and most importantly, monthly gross income and the debt-to-income ratio (DTI). According to Lending Club, the DTI is calculated with the borrower’s monthly debt payment obligation (from the borrower’s credit report) divided by monthly income. However, this calculation does not include mortgage accounts or the loan’s expected monthly payment. Honestly, I found this calculation quite weird though. The monthly loan payment as well as mortgage should be included in the DTI calculation in my opinion. What’s the likelihood of making late payment for the borrower who, for example, makes $2,500 every month but has to pay $500 monthly loan payment and $800 mortgage payment on top of $1,000 revolving credit balance? So in the case, I won’t simply look at the DTI and conclude that the borrower has a low debt obligation if the DTI is low. I will instead combine the borrower’s income, monthly payment, mortgage/rent payment, and credit card balance to determine the debt-to-income ratio.
Borrower’s Credit History
In fact, I don’t too much attention to the borrower’s credit score because, as we know, a lot of factores could affect a person’s credit score. If the borrower only has a short credit history, his/her credit score won’t be high, but that doesn’t mean the borrower is not responsible. When reviewing the borrower’s credit history, obvious information such as delinquencies are important, so are the borrower’s revolving credit balance, credit utilization ratio, and recent inquires. A high utilization ratio is alarming, but not necessarily mean the borrower abuses his/her credit (if, for instance, the borrower maxed out a 0% APR card he/she recently obtained, the ratio is likely higher). While I won’t focus too much on the credit score itself, I will, however, try to get a little more information if the borrower’s credit score dropped since the loan was initially listed.
BTW, the borrower’s credit history shows when the earliest credit was opened. I will be more interested in when the latest credit was opened.
The borrower gives potential lenders the story on why the money is needed and what it is for. However, since the description is not verified by Lending Club or anybody, there’s no way to tell whether what were told are true ot not. In general, I’d prefer a borrower tells us a story than those who didn’t say anything. I noticed lately that more and more people are using Lending Club to consolidate their credit card debt by getting rid of high interest rates credit cards and using Lending Club’s low interest loans instead.
Here I can get a feeling of whether the borrower has a stable job, thus a stable income. In this economic environment, layoffs are massive and everywhere. A stable job (if there’s one) means payments are unlikely to be interrupted.
Questions & Answers
If I still have questions after going through all the information above, I can write to the borrower in the Q&A part, asking for clarification. For example, I mentioned that I will take the borrower’s monthly mortgage/rent payment into account when calculating the DTI, but the information is not directly provided in the borrower’s profile. I will need to ask the borrower to give me a number. Actually, I can submit any relevant question to the borrower in the Q&A section. If the borrower clearly answered my questions to my satisfaction, then I will be happy to fund the loan. If the borrower isn’t straightforward, then I’d rather stay away.
On one hand, I want to protect myself by avoiding investing in loans that appear to be too risky. On the other hand, peer-to-peer lending itself carries a significant level of risk. During the loan selection process, I want to evaluate every piece of information carefully from the beginning so I won’t regret my decision should something bad happen later. However, there’s no guarantee that a loan will stay current through out the 36-month period. The risk is always there. If you want to get into the P2P lending business through Lending Club, doing your homework (evaluating each loan thoroughly and carefully) may reduce the risk of default of your investment, but can’t avoid it. That’s why you could receive much better return from lending to other people than to banks
So, what’s your way to evaluate Lending Club loans?
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