Lending Club Note Trading: Another Way for Peer-to-Peer Lending
Lending Club is a SEC registered leading peer-to-peer (P2P) social lending platform, where borrowers with excellent credit can borrow money with rates starting at 7.88%. Lenders can enjoy an average 9.05% loan return.
I have been thinking of getting into peer-to-peer lending as alternative way to invest for quite some time, but the idea has been put off repeatedly because I wasn’t sure about the prospect of making meaningful money from it. Even though the returns on loans at peer-to-peer lending sites such as Lending Club and Prosper, are much higher than what I would get from bank savings accounts or, some times, even stocks (I am talking about bad years like 2008), the risk of default by lending to other people is definitely much greater too. Besides, to make any meaningful money from P2P lending, the size of the investment has to be large enough, a commitment that I wasn’t willing to make before because the money will be tied up for extended periods, depending on the length of the loans. In other words, money in peer loans is not as liquid as I want it to be and I don’t have much to spare.
Why Peer-to-Peer Lending
However, recent developments in the credit market finally pushed me to make the decision to get it started. As we know, the crisis in the financial market has made loans, whether for businesses or individuals, hard to obtain these days, unless you have a perfect credit and a stable income. As a result, peer-to-peer lending has become a booming business as many people seeking loans turn to Lending Club, Prosper, or Virgin Money for help from total strangers. In fact, P2P lending site Lending Club has received quite some media coverage lately. For example, a couple of weeks ago, Harvard Business Review profiled Lending Club as the place “people come together to create a pool of capital” and “the potential for wealth creation.”
Lending Club Note Trading Platform
As I was just about to use Lending Club for my P2P lending, I was quite disappointed initially when I noticed that New Jersey, where I am currently living in, isn’t one of those states whose residents can buy notes directly from borrowers Fortunately, Lending Club has an alternative system, called Note Trading Platform, for lenders like me. As the name suggests, the Note Trading Platform is a market place where notes, or loans, buyers and sellers meet. For those who don’t qualify to lend on the primary market, the Platform is the only place where you can become a lender by purchasing notes (or loans) from others.
Among peer-to-peer lending operators that I know of, Lending Club is the only SEC registered P2P lending platform, which allows them to offer this secondary market. Another benefit of this secondary market is that lenders who invest in the primary market can turn some of part of their investment into cash, solving the concern of liquidity I had initially. Lending Club’s Director of Product Strategy, Rob Garcia, tells me many lenders are taking advantage of this feature: “We have observed great adoption of the Note Trading platform since we launched it in Oct of last year, resulting in a fast turnaround time of no more than 1.7 days when selling notes at or below par value”.
The good thing with the Trading Platform is that there’s no extra fee for lender from Lending Club (the notes sellers will pay LC 1% fee of the purchase price). Of course, if I use Trading Platform, there’s always a possibility that I could pay more than facing value of a loan, which could be the “extra fee” comparing to lending directly. Therefore, to reduce costs and be more profitable, I want to buy loans that are sold on par value, if not at discount. Paying a 1% premium is fine, but not more than that. I am not in a rush to spend the money, so I can always wait for the right loan at the right price.
The first step of buying notes through the Trading Platform is to see what are on sale. When browsing notes, there are several criteria to make searching a little easier. For example, I can select average rates (from 8% to 17% depending on borrower’s credit rating) of the loans, whether the loans are current or late, and how many payments remain.
For me, the reason I am in P2P lending is to make more money than from, say, bank accounts. Therefore, I am only interested in loans with good rates, even it means I will have to take higher risk (of course). As shown in the above screenshot, the search results show some basic information of the loans, such as status (current, issued, or late), change of borrower’s credit score, remaining payments, asking price, and markup/discount, etc. Though I am willing to take a higher risk, I can’t lend money to people who were late in making payments. So in my search, I excluded loans with late payments.
As I mentioned above, I am not interested in overpaying a loan. So the late column, markup/discount, is the information I am most concerned about because that’s what I will pay if I acquire the loan from the seller. Once identifying the notes with the right prices (all at slight discount), I checked a few more details of one of my targets:
As you can see, the loan’s interest rate is closely related to the borrower’s credit score (see more about how LC determines rates based on credit scores). In this case, the borrower’s credit score is pretty good and had no late payments. If I want to find more about the borrower, there’s a link to the original listing on LC where the borrower’s profile including income, homeownership status, employment, and brief credit history are listed. All of these can help me evaluate the credit worthiness of the borrower, but they are not critical to me. People with low credit scores aren’t necessarily going to be late in paying bills and it’s entirely possible for people with perfect score to make late payment. Therefore, I’d pay more attention to payment history than credit history.
Loans offered at LC have several sizes from $25 a piece to hundreds of dollars. Because of the inherent risk of lending money to other people, it makes more sense to spread the risk among a large group of borrowers of small loans instead of making large loans to a few people. In my first purchase, I only selected loan sizes of $25 and $50 and the total number of notes I bought is 10.
The purchase process at Lending Club is quite simple: After selecting the notes I want to buy, I submitted my order for approval. Within one day, my order was approved (orders submitted before 2:00 pm EST are settled the same day; otherwise, the next business day) and I am officially a lender
This is the first time I tried peer-to-peer lending. My initial concern about the default is still there. However, I think the risk is effectively mitigated by investing a large number of small loans. The more number of people I lend with the same amount of money, the lower the overall risk, given that each borrower has an acceptable credit score. Since there’s no way to predict what happens in the future, I can only use past payment history to make a decision. However, the drawback with the lending by buying notes is the smaller the number of remaining payments (thus, the longer the payment history), usually the higher the price of the note, which I am not willing to pay. If I buy loans with the full 36 payments remaining (loan status as Issued), then there’s no history for me to check. In this case I have to rely entirely on the borrowers credit history.
Even though it appears to me that risks of peer-to-peer lending is acceptable and the earning potential is quite big, I don’t expect to make much money from it for two reasons: First, to make any serious money from P2P lending, the size of the investment, like any other investments, is the key. On one hand, I am not going to make anything meaningful if I only put down a few hundreds of dollars. On the other hand, I am not ready to set aside anything more than a couple of thousands for P2P lending, which means earnings are limited, at least at the beginning. Second, the secondary market like Note Trading solves some of the liquidity problem, but not all. I can list loans I own on the market when I need cash, but there’s no guarantee on how long the notes will find a buyer even if I price them right. If there’s no taker, then I will have to keep holding them. This shouldn’t be a big problem as the secondary market seems to be quite active (many notes are on sale with a premium, not discount), but needs to be keep in mind.
Despite these, I am glad I took the first step in the peer-to-peer lending business and my initial experience with Lending Club is quite positive. I’d even happier if I can make money from P2P with Lending Club
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