If you are thinking about getting a personal loan at Lending Club or Prosper, you may be wondering about the interest rates and fees. After all, almost nothing is free in this world. Lending Club and Prosper are both private companies who need to turn a profit to stay in business, so how do they get paid when you get a loan?

In today’s post, we will break down how Lending Club and Prosper make money off your loan. In short, they make money from borrowers in two different ways: the origination fee and the interest rate. There are some random fees besides these, but those are main two. By the end of this article, I think you will discover these fees to be both both simple and affordable.

Origination Fees at Lending Club & Prosper

If you take out a peer to peer loan, you will be charged something called an origination fee. The word ‘origination’ comes from the word originate, which basically means ‘to begin’. So this is the fee Lending Club and Prosper charge to simply create your loan. Think of it like the loan’s activation fee, like the fee a cellphone company charges when you first sign up for their service.

The fee is charged in a very simple way. If you get a company like Lending Club to approve your loan of $20,000, and their origination fee is 4%, they won’t actually charge you a fee up front. Instead, they take 4% out of the lump sum they deposit into your bank account. So for a $20,000 loan with a 4% origination fee, they would simply deposit $19,200 into your bank account at the beginning of the loan process. The “fee” is them simply withholding $800.

For example, I took out a Prosper loan for $2,350. The origination fee was 1.95%. When I got approved for the loan, Prosper deposited $2,304 into my checking account, taking $46 as an origination fee. I got a Lending Club loan for the same amount ($2,350). My Lending Club origination fee was 4.0%. So I had $2,256 deposited into my checking account, with Lending Club keeping $94.

In short, both Lending Club and Prosper simply kept back a small percentage of the loan before I even began repayments. This was the origination fee.

Lending Club and Prosper generally charge a 5% origination fee

The origination fee you pay for your loan will depend on your loan rate. The safest borrowers with the best credit pay the lowest origination fees, while mostly everybody else pays a 5% fee. You can see the origination fees for both platforms in the table below:

This fee is important to consider when you apply for a loan. For instance, if you need an exact amount, like $10,000, and your origination fee is 5%, then you should ask for $10,526. $526 will be taken in the origination fee, leaving you with the full $10,000 amount.

Interest Rates at Lending Club & Prosper

The other way that these companies charge borrowers is through the interest rates on the loans they issue.

How important is a good interest rate?

Loans at Lending Club and Prosper amortize, similar to a home mortgage, so amortization calculators around the internet can all show how repayment happens. For example, let’s say Lending Club assigns your $10,000 3-year loan an interest rate of 9%. If you go to a site like Amortization-calc.com, this will mean you make 36 payments of $318, eventually paying $1,448 in interest over the loan’s three-year term.

When I got a $2,350 loan at Lending Club, the interest rate they assigned me was 12.99%. For three years, this meant I would pay 36 payments of $79.17. See my loan below:

(click to zoom)

Everybody’s interest rate can be different, but getting a lower interest rate matters a great deal. Let’s say the 3-year $10,000 loan mentioned above had a 19% interest rate instead of a 9%. Instead of $1,448 in total interest, you would pay $3,196 in interest over three years. That is a difference of $1,748 for the exact same loan. Obviously, this interest rate is really important to consider if you would apply for a peer to peer loan.

Interest rates at Lending Club and Prosper

At both platforms, your credit worthiness will be looked at, and you will be given a grade. Safer borrowers with excellent credit may be given an A-grade loan. Those with less than perfect credit scores may be given a D-grade. This grade is tied to your interest rate, so getting a higher grade loan means you will pay less total interest.

Generally, both companies offer the same interest rates. Lending Club offers borrowers an APR between 6% and 28%. Prosper offers rates between 6% and 34%. Basically, borrowers with the best credit have a rate closer to 6%, and the average borrower at both Lending Club and Prosper has an interest rate of 15%.

How to qualify for a lower interest rate

The way Lending Club and Prosper assign you an interest rate is complicated. People looking for a loan often ask how to get the lowest interest rate possible. A quick answer is to have (1) a great credit score and (2) lots of income, but there are actually hundreds of variables that go into a credit score (see this breakdown).

That said, here are three strategies you can use to help lower your Lending Club or Prosper interest rate:

1. Only apply for as much as you need (bigger loans have higher rates)
2. Choose three year loans instead of five year loans (longer loans have higher rates)
3. Wait for recent inquiries on your account to age

The first two are simple. The larger the loan, the higher the interest rate you will be charged. Next, try to only take out a three year loan, as these carry a lower interest rate.

The third suggestion, waiting for recent inquiries to age, is a little more complicated. Each time you apply for a line of credit, whether a loan or a credit card, your account receives a hard inquiry (also called a hard credit pull). The more hard inquiries you have on your account, the higher an interest rate you may be charged on a peer to peer loan. It might be a good idea to wait for a few months so as to let any credit inquiries become older than 6 months, whereupon you can apply for a peer to peer loan with a lower possible interest rate.

But as I said earlier, the best way to get a better interest rate is to improve your credit score. Check your credit report regularly (using sites like this), making sure your report is free from late payments or errors. Consolidate and pay down your debts. If you need a starting point, this article has some helpful hints. Borrowers with excellent credit receive the very best rates when taking out a peer to peer loan.

Compare your rate at both Lending Club and Prosper

That said, the simplest way forward for most people is to check their rate with both Lending Club and Prosper and go with the company that offers them the lowest rate.

When I applied for a $2,350 loan with both, Prosper gave me a rate of 8% while Lending Club offered me 13%. Obviously there is a big difference between those two numbers, so I suggest you check your rate with both companies and go with whichever is lowest.

Other Fees: Failed Payments, Late Payments, and Check Cashing

There are just a few remaining fees within a peer to peer loan, and these are special fees that you are charged if your account has trouble.

$15 Late Fees at Lending Club & Prosper

Each month you are required to make on-time payments on your loan. Typically these payments are automatically taken from your bank account. However, if your account runs into trouble and your payment arrives over 15 days late, the platform will charge you a fee of $15. For instance, if your bank account has insufficient funds and your payment eventually comes in three weeks late, you will be charged a $15 late fee.

Failed Payment Fees

Additionally, the platforms may charge you a fee for every failed payment. For example, if you close your bank account and forget to update your account at Lending Club with the number of a different one, the electronic payment will fail and Lending Club will charge you a $15 fee.

Check Cashing Fees

Finally, the platform may charge you a fee for paying with a personal check. Lending Club, for example, charges borrowers $15 for loan payments paid with a check, obviously preferring people to make the payments electronically through a bank account.

Conclusion: Peer to Peer Loans Have Simple Costs

Compare this list to something like the terms and conditions of a credit card, and you will marvel at the difference. For example, credit card companies often raise the rates of people who are late on their payments. And if you do not pay off the interest, it will be added to the amount you owe, so will have to start paying interest on the interest! How confusing.

Peer to peer loans, in contrast, are remarkably simple in their rates and fees:

1. A one-time origination fee (typically 5%)
2. An interest rate (typically 14-15%) that can never go up, even if you are late on a payment
3. A $15 fee for things like late or failed payments

That’s it! One fee, one rate, and a reasonable late fee, further proof that peer to peer loans are simpler and cheaper alternatives to getting a loan through a bank.

Check your rate at Lending Club & Prosper (won’t hurt your credit score)

The post Interest Rates and Fees on Lending Club & Prosper Loans appeared first on LendingMemo.

I just returned yesterday from the annual LendIt conference in San Francisco, a hearty gathering of investing professionals dedicated to exploring how the internet is transforming American finance. Lending Club and Prosper, obviously the industry’s biggest hitters, contained the largest presence at the event, giving rousing speeches that packed out the grand ballroom of the Union Square Hilton Hotel downtown. The sheer excitement people have for these two platforms alone was an amazing thing to experience.

My responsibility throughout the two-day event, however, was leading the smaller workshop/demo track, basically the room where companies could come and give short seven-minute presentations about their work, perhaps leading the audience in a demonstration of their company’s product via a projected web browser. The entire room could only seat a few hundred people at most, so while Lending Club and Prosper remained in the larger presentation hall, I had the very real privilege of meeting the founders and developers of these smaller companies first hand.

Introducing fifty different companies over a period of two short days, I met a wide-ranging collection of professionals covering nearly every facet of online lending. Getting introduced to all of these talented people and their companies turned out to be a huge opportunity for me to receive a crash course in the online lending movement. Lending Club and Prosper remain the only two options available for unaccredited investors, the focus of this site, so the lion’s share of my attention has historically been given to them. However, this firm focus has also meant that I have largely abstained from the wider conversation around finance and technology in general, a lack of awareness that changed for good at LendIt 2014. Introducing fifty startup presentations in 48 hours meant receiving a sudden bird’s-eye macro-level view of internet-driven finance, a jump into the deep end of online lending itself. Now that the conference is over, I have a lot of thoughts about the industry as a whole, a few critiques, but largely a feeling of amazement toward what is happening in our world today.

A perfect illustration of the how the web is transforming the American economy was given in a talk by David Snitkof of Orchard Platform. During his short workshop/demo presentation, David shared a graph that looked something like this:

As a caveat, I recreated this from memory, so forgive me if I get some of the titles wrong, but I feel the gist of his graph is adequately represented.

Human economies began as hunter-gatherers, but soon evolved into tradesmen (like cobblers and blacksmiths) who could add expertise and personalization to the products people needed. The industrial revolution then added incredible scale to this economy, but at a cost of making it both lower-quality and impersonal.

The LendIt conference heralds the arrival of Act 4, how the influx of technology and the internet is forming a new economy that is both large-scale and humanitarian. For example, a peer to peer lending company like Lending Club uses risk-based pricing to give people an interest rate on a loan that is more appropriate to their situation (personal), yet is able to issue billions of dollars of these personalized loans using just a few hundred employees (scale). David’s point was that the internet is simply grabbing an already-scaled global economy and reforming it into something more excellent and human.

By the end of the conference, I had to agree. For example, I was truly amazed by the presentation Dave Girouard gave regarding his company Upstart. For those unaware, Upstart offers loans to people who have yet to build any credit history, but who are fresh graduates from promising colleges. Considering many grads have not yet had the chance to develop a FICO score, a great number of responsible deserving individuals are unable to get a loan. But Upstart has developed a novel risk-model that determines creditworthiness based on factors like a person’s academic transcripts. And so, just like Act 4 in David’s graphic, Upstart has invented a scalable business model that utilizes technology and the internet to offer a service that people deeply need. To boot, their company had arguably the most beautiful website at the entire conference.

Upstart was just one of many. Throughout the day, I continued to be amazed by intelligent, heartfelt individuals who had found creative, tech-based approaches to solving society’s credit issues in a way that could nationally scale. Noah Breslow from OnDeck gave a talk that made issuing small business loans sound heroic. Jared Hecht showed how his company Fundera has developed a clever online marketplace for offering businesses loans. Peter Behrens from the UK-based p2p lender RateSetter spoke about how his company actually dressed up as zombies and roved the streets of London to raise awareness of the fact that 80% of people in the UK have “zombie” bank accounts, meaning savings accounts that return less than the rate of inflation, and thus could be classified as living-dead.

Fifty presentations in two days sort of began to blur together for me by the end, and a wider view began to take shape. First, I was amazed by the degree of intelligence within this movement. Many of the conferences I’ve attended over the years that emphasize the arrival of technology are largely motivational in nature. In contrast, online lending in general (and LendIt in particular) is largely empowered because it is smart. You simply cannot scale a credit-model without statistics, and you cannot base a company around statistics without having some very intelligent people on board. Full stop.

Secondly, I have to admit how moved I was by the palpable courage of the online lending movement. While an element of money-hunger was certainly present if you sought it out, the overwhelming majority of people I introduced in the workshop/demo-room revealed themselves to be experts who believed in their work because of the service it provided to people who need it. Whether it was helping small businesses, empowering fresh graduates, or simply consolidating ugly credit card debt into something more simple and manageable, the startups who embody this renewal of the American financial sector contain a heart-warming degree of kindness and humanity.

Maybe this quality is simply representative of this industry’s naïve beginnings. Perhaps, decades from now, we will look upon the idealism of these earlier years as indicative of the movement’s initial youth and venture-funded roadmaps.

However, I think another real possibility exists, the possibility seen in David Snitkof’s chart. These tech-based financial startups may be cutting out the banks and reforming American finance, not through offering still-larger opportunities to scale, but for the element of humanity they can inject into the sizable economy that already exists. In this way, the intelligence and kindness of this movement may be the very driver of its success, and thus a permanent characteristic of national finance moving forward.

The post The Intrinsic Humanity of the Online Lending Revolution appeared first on LendingMemo.

One of the hardest parts of running a small business is getting access to a loan when you need it. Larger businesses with hundreds of employees that make millions of dollars in revenue per year might have access to credit through a bank, but small businesses are often left out in the cold. Especially since the financial crash of 2008, access to loans has been a consistent challenge for the small business owner.

This all changed just a few months ago in March when Lending Club, one of the largest issuers of personal loans in the country, officially began issuing small business loans of amounts up to $100,000.

They had already been issuing billions of dollars in loans to individuals for the past seven years. Lending Club did this so well because they run completely online. A traditional bank has far more overhead, having to maintain local branches and a huge employee base. In contrast, Lending Club operates completely through the internet. Since their website costs amazingly less to run than the national chain of a major bank, Lending Club passes the savings on to its customers in the form of lower rates.

In summary, Lending Club has become a successful company through offering the lowest interest rates nationwide.

Lending Club Offers Business Loans with Lower Rates & Fees

Lending Club has expanded into business loans while using this same online-only approach. The result is a loan with a lower interest rate than anywhere else. So unlike applying for a loan at a bank, the entire application process is completed online. This includes the initial process where you get quoted for a rate, as well as the verification stage where you are asked to submit documents and information to prove you and your company’s identity.

But the end result is the same: lower rates. For example, here are the interest rates for business loans (source – Lending Club):

As you can see in the chart above, Lending Club offers interest rates between 5.9% and 29.9%. The rate you receive will depend on the credit of your business. The more creditworthy your business is, the closer your loan rate will be to 5.9%.

Origination Fees Between 1-6%

The other column in the above chart is the origination fees on these loans. What is an origination fee? This is what Lending Club charges for the loan to be issued. Think of it like the activation fee for getting a new cell phone. Basically, it is the main way that Lending Club makes money from these loans. The way they charge it to you is by simply removing it from the lump sum they transfer to your bank account.

This means that if you are approved for a $20,000 loan with an origination fee of 2%, you would have $400 removed from the deposited amount, so Lending Club would deposit $19,600 into your business bank account.

As you can see, the origination fee depends on the interest rate each loan is given. Business loans with lower interest rates generally have a lower origination fee. The amazing thing is, even if you include the origination fee into the interest rate, Lending Club still has lower overall rates than anywhere else.

Lending Club Business Loan Details & Minimum Requirements

Here is the official description of the loan as provided by Lending Club:

• Fixed Rate: 5.9 – 29.9% (never changes, even after a late payment)
• Term: 1-year, 2-year, 3-year, or 5-year loans
• Minimum/Maximum Loan Amount: $15,000 to $100,000
• Unsecured: No collateral required — just your signature.
• Pre-payments: No fee. Pay back the loan early at any time.
• Late/failed payment: $15 fee

Minimum borrower requirements:

• Annual Business Revenue: $75,000 or more
• Ownership: 2+ Years
• FICO (credit score): 620+

It is worth mentioning that Lending Club looks at both the FICO/credit of the applicant and the financial documents of the business during the application process. So if you have perfect credit, yet your business brings in just $20,000 per year, you will likely be denied.

How to Apply for a Lending Club Business Loan

The easiest way to apply is to go to the Lending Club website and check your rate. The initial form is very simple (seen below). Fill out (1) the amount of the loan you need, (2) the purpose for your loan, and (3) click Get Started.

After hitting Get Started, you are taken to the first page of the loan application:

After filling in some information about yourself, you are brought to the second section of the application where you specify your business financials:

(click to see full application)

That’s all there is to it. Once you click the green Continue button above, Lending Club will calculate whether or not you qualify for a loan, as well as offer you an interest rate. If you decide to accept the loan offer, they will begin the verification process to prove your identity. Once this is complete and your loan is funded by investors, it is officially issued and the money is transferred to your bank account.

Only 45 States Allow Lending Club Business Loans

The majority of the United States, forty-five states in total, allow Lending Club to issue loans. However, applications are not accepted from Idaho, Iowa, Maine, North Dakota, or Nebraska. As of May 2014, the security regulators in these five states still have concerns that forbid Lending Club from operating there.

Lending Club in the News

All of this may seem new to those of you who have never heard 0f Lending Club. To help, here are a few articles in major news outlets talking about their business loan program:

• Lending Club Makes Small Business Loans (BusinessWeek)
• Lender Expands into Small Businesses (Wall Street Journal)
• Google-Backed Lending Club & Business Loans (TechCrunch)

Conclusion: A Great Business Loan at a Low-Rate

In today’s tough economic conditions, being approved for a loan can mean fresh life to a struggling small business. However, large American banks have often failed to give these people the credit they deserve.

Lending Club’s small business loan program was launched in March specifically to aid this situation, particularly for  businesses run by responsible creditworthy individuals. And since Lending Club operates completely through the internet, they are able to offer lower interest rates than any bank. Combine this with the loan’s easy online application, its low late fees, and its freedom to pay off the loan early without charge, and you’ve got a great option for any small business owner nationwide.

Check your rate at Lending Club (won’t hurt your credit score)

The post Lending Club Business Loans: Low Rates & Easy Terms appeared first on LendingMemo.

One amazing thing about this asset class is the blistering speed with which it changes month by month. Already the Lending Club screencasts I made in February feel out of date because Lending Club updated their site with a much needed design overhaul.

Today I am pleased to share that LendingMemo’s peer to peer lending eBook has been freshly updated with new design, copy, and graphics for 2014. At over thirty pages long, it remains the most comprehensive introduction to peer to peer lending on the web.

To get the guide, complete the site’s free registration.

The post Revised and Expanded: Free Peer to Peer Lending eBook appeared first on LendingMemo.

With a Lending Club IPO on the horizon, and peer to peer lending receiving accolades in major press outlets for its innovative approach to helping both borrowers and investors, I want to pause a moment to focus on the retail investors of this asset class. We can herald the 8% returns peer to peer lending offers, but if this return is simply going to a tiny sliver of the country’s investors, how is that a significant national milestone?

On the contrary, this asset class is unique for the opportunity it offers to the nation as a whole. In this spirit, let me begin today by asking a question: for people who invest with an average of $12,000 (retail investors), what is the state of peer to peer lending?

Retail Investors on Prosper Marketplace

During my interview with Prosper’s CEO last month, Aaron Vermut spoke about how his company needed to grow its institutional investor base (banks, hedge funds, etc) in order to get the company off the ground. While Prosper had tried for years to grow through small-dollar investors, the company realized that hitting profitability required investors with much deeper pockets.

Vermut was pleased to share that these new institutional partners had fostered Prosper’s growth to the point where they were finally making money on each loan. With profitability out of the way, Prosper could now focus on growing its retail investor base.

This is a welcome change from the past season. Last quarter, it was not uncommon to see just a few A & B-grade loans available on the platform. See this tweet from February:

In the interview, Vermut spoke of his eventual goal to have retail investors comprise over 50% of the platform. While big-dollar investors were helpful at getting the company rolling, everyday Americans are much better at sticking with the company when times get tough.

“Hedge funds, if the climate changes, may be gone. A lot of these other guys have leverage, and the leverage providers are all the same people, and that creates correlation. If one bank says it is done, then everybody using that bank is done as well.” … “That is why retail investors are so important.” (read: Vermut Reflects on Prosper’s $1B issued loans)

To help get started, Vermut stated how Prosper will be increasing availability of loans on the retail side of their platform. And recently they have been doing exactly that. In contrast to February’s sparse numbers, there were hundreds of loans available on their platform today:

Retail Investors on Lending Club

Prosper has a good example to imitate. Lending Club has had a healthy retail investor community for years that supports an incredibly large volume of available loans. For example, there are currently over 1300 loans available on Lending Club’s site today:

How large is Lending Club’s retail investor community? Around 40,000?

I have been wondering about the size of Lending Club’s retail community for years. Around 1pm yesterday, Lending Club sent the following email to their retail investor community:

Basically, Lending Club sent out this email to show how popular its automated investing option is. In it, they gave some statistics about the program’s success:

• In April, Automated Investing (previously ‘PRIME’) placed more than 386,000 orders, an average of roughly 7.8 orders per account per week.
• More than 54% of all retail orders were placed in April via Automated Investing.

Aside from demonstrating the popularity of their new automated option, this email also gives us a clue to the size of their entire retail community. If 386,000 orders were placed via Automated Investing last month at 31.2/month per account (7.8 * 4 weeks), then there are 12,371 accounts using Automated Investing. If Automated Investing orders comprised 54% of orders, this also means Lending Club’s retail community placed around 714,815 total orders in April. Finally, if every account placed 31.2 orders last month, both automated and manual accounts, this means there are at least 22,910 active retail investors on Lending Club.

I actually think this estimate is too low. First of all, this calculation assumes non-automated investors had the same number of orders per month as automated ones. But those who invest manually would have a much smaller number of investment orders per month, perhaps ten or less. So while we can be more sure that 54% (12,000 investors) are using the automated option, the remaining 46% of the orders would be triple this estimate. So I actually peg the total number of active accounts in April to be above 40,000.

Whatever the case, it is these tens of thousands of investors that allow Lending Club to put out fantastic charts like this (found here):

5 Factors to Catalyze a Thriving Retail Investing Community

As someone who desires this entire asset class to grow in health and popularity nationwide, I have great hopes that Prosper will soon be able to have an equally large population of average Americans participating on its platform as well. In this spirit, I would like to offer five platform factors to help make this happen. Obviously, the most important is a low default rate and a consistent return, but here are five additional drivers of growth:

#1. Loan Availability

It is really refreshing to see Prosper having hundreds of available loans on the platform these days. Back in February, when I was completing LendingMemo’s first video series, I had to skip over their screencast for this reason. However, these days the retail environment on Prosper is much more approachable, brought on by hundreds of newly available loans.

The two big reasons for availability are (1) diversification and (2) choice. First, investors need hundreds of loans on the platform if they want to easily create a diversified account in two hundred loans. Second, they want a few different risk-grades to choose from. Few investors want to be pigeon-holed into A-grade loans.

#2. Web Design

I am a believer that a website’s overall aesthetic and design is crucial for repeat customers and the brand-momentum this brings. In this way, I think both Lending Club and Prosper have some work to do. Prosper actually had a much-welcomed redesign last year (Lend Academy), and Lending Club recently completely redid theirs as well. However, both the sites could be further streamlined and simplified to look more like Upstart (below).

If peer to peer lending is to become a staple of investing for the average American, it will require a website that makes the experience simple, easy, and pleasureful. I actually think Prosper and Lending Club have a huge opportunity here. Financial websites are notorious for verbose, blocky design that makes investing a burden (example | example | example). As these nimble loan platforms innovate each year, how great would it be for one of them to become the first financial website nationwide with an award-winning design?

#3. Auto-Investing Tools

I never thought I would say this, but Prosper has finally been (slightly) outmatched by Lending Club in the area of automated investing. True, Prosper’s filtering continues to be much finer than Lending Club’s, which is lauded by precise filterers like myself (the minority). However, Lending Club’s new shiny Automated Investing has emerged as an option that seems both easier to understand and set up. Heck, they made it a link on their site’s main navigation.

For peer to peer lending to be a popular and widespread practice, easy-to-understand automated tools need to exist that allow the average busy investor the freedom to only log in a few times per month or less.

#4. API Regulations

As I covered in my post last month on screen-scraping, Lending Club has shown itself to be somewhat hesitant to open up its API functionality (used by those with investing servers). Prosper, on the other hand, has generally kept its API wide open. Both these approaches have their drawbacks and advantages, with Prosper’s open API resulting in investor dollars being better/quicker put to work. However, Lending Club’s half-completed API means that small-dollar investors have often had more available loans to choose from.

Prosper actually did a great job adding some restrictions to this API (Lend Academy). Originally, investors could not pick up more than 50% of a loan. So if a $10,000 loan was added to the platform, the max any investor could pick up was a $5,000 note. However, this resulted in a small population of large-dollar investors vacuuming up the lion’s share of the available loans. As a result, Prosper changed the max to just 10%. The result of this change was, of course, a sudden jump in available loans on their platform, a better overall environment for retail investors.

I am really interested to see how the Lending Club and Prosper APIs mature in the coming years. I imagine they will continue to refine a server interface that balances the needs of both large and small-dollar investors.

#5. Time

One of the biggest things a retail investor community needs to get going is time and patience. While large-dollar institutions can efficiently be flown in and marketed to, it may be a longer process to build a consistent thriving population of retail investors at a site like Prosper.

Having spoken at length with the management of this company, I believe Aaron when he says he wants retail investors to comprise the majority of his investor base in the coming years. In this way, I have taken a very patient approach toward the growth of Prosper’s retail community. Institutions have moneymen they pay to look at the thick data before jumping in, but the average small-dollar retail investor begins through recommendations from trusted friends and family.

Trust may take time to form, but as Prosper’s CEO said in his recent interview, this is how hundred-year companies are built.

[image credit: Bruno Corliodi "Grown-up"
Cliff "Pasture juniper (Juniperus communis ssp. depressa)"CC-BY 2.0]

The post The State of Retail Investing in Peer to Peer Lending appeared first on LendingMemo.

One afternoon in late 2013, I was sitting with a close friend at a local diner, talking about the potential that peer to peer lending has to transform the way our country interacts with its finances. Over cups of coffee and slices of marionberry pie, my friend asked me which angle of that picture excites me the most. Without hesitation, I mentioned the way this asset class gives people agency over their personal investing, the refreshing degree of control it offers them over their own future. Indeed, what continues to captivate me today is the liberty in peer to peer lending. It offers a consistent and lucrative return to anyone who possesses the ability to understand basic financial concepts (diversification, risk, and so on), irrespective of their economic or social status.

However, this is not the current trend of things. As this asset class becomes more and more popular by the month, the bulk of its demand is coming from deep-pocketed financial institutions who possess the wisdom to know a good thing when they see it. This is both expected and welcomed, for their capital is largely responsible for the new stability of this asset class. However, the picture that captivates both Lending Club and Prosper is how this industry is transforming the country’s financial fabric, how it connects people who need money with people who have extra to lend.

This remains the captivating vision for myself as well. It is the reason why LendingMemo has only half-covered the numeric monthly issuance of Lending Club and Prosper. While billions of dollars in new online consumer loans is a wonderful indicator of the strength of this asset class, and as much as it has helped thousands of Americans consolidate their debts at a more reasonable interest rate, this same popularity has not been equally mirrored on the lender side. The real metric at Lending Club and Prosper that I celebrate is not so much the staggering originations, but more the numeric growth of its investor population.

As I sat with my friend in that diner, I realized the part that LendingMemo can offer toward the wider story of peer to peer lending, particularly that of education and advocacy. While continuing to celebrate the historic rise of this asset class as a whole, this site seeks to remain acutely captivated by the way peer to peer lending democratizes personal investing, and seeks to engender the country with this same captivation. As average Americans read in the press about this new exciting way for them to invest, the need remains for an educational arena to help them get started. This is the role that my company is offering to play.

This site is unveiled today as a space to champion the retail investor.

My friend and I finished our coffee and left. That same evening, the first sketches of a framework were laid for what a peer to peer lending educational site would look like. Months of conversation and hard work ensued. Today, I am very proud to unveil LendingMemo as a hub for average Americans to discover and begin lending money online. With an aesthetic both intelligent and popular, with an always-free membership that seeks to fill itself with approachable and smart content, this site is unveiled today as a space to champion the retail investor.

Click to see the new course area

As the Lending IPO draws closer on the horizon, offering to unlock investors in all 50 states, and as Prosper emerges as their equal, providing fresh competition and energy within this industry, I am so eager to see the national picture that is set to unveil. Give it eighteen months – this country will never be the same.

[image credit: Chelsea Nesvig "marionberry pie" CC-BY 2.0]

The post Meet the New LendingMemo: Peer to Peer Lending Made Easy appeared first on LendingMemo.

Last month at LendIt I was able to sit down with Lending Club’s Renaud Laplanche and talk about how his company has plans for an IPO.

In my previous interview, Laplanche spoke at length about how Lending Club’s cost-advantage, empowered by their lean internet-driven infrastructure, has the potential to cut out the American banking establishment. This time, the focus was less on their inherent efficiency and more on Lending Club’s need to simply catalyze national awareness.

Interview with Lending Club’s CEO

In a sentence, how would you define an IPO?
An IPO is an initial public offering, so it is an opportunity for the general public to become shareholders of the company.

What steps does an IPO require of Lending Club?
The first step is really just a readiness assessment. Once you are public, you need to release financial information every quarter in a way that is very reliable. So you need internal controls, accounting systems, and financial models that allow you to do that. Lending Club has completed this phase.

The second step is when you push the button and go. This phase involves selecting bankers and underwriters that will help the company through the process. Once the bankers have been selected, there is a drafting of the offering prospectus that will be filed with the SEC. The SEC then generally takes two to four months to review and comment on the prospectus, which can often have several iterations.

Then there is a roadshow for a week or two, which is just a presentation to the wider investor community. Finally, the deal prices and the stock trades.

That’s quite an involved process. Why does Lending Club desire to become a publicly traded company?
There are typically three reasons why a company goes public, though interestingly only one really applies to Lending Club.

The first reason companies have an IPO is to raise capital, especially if they are not yet profitable. Many internet companies go public for this reason. Perhaps companies have a lot of operating costs and want to grow in a faster, cash-flow negative way. But this reason does not apply to us since Lending Club’s operations are already cash-flow positive.

The second reason companies go public is to provide liquidity for existing shareholders. Often, venture capital firms invested early on with a seven or eight-year time frame. Going public can be a way to let the earliest investors sell off their shares to the public. However, shareholder liquidity is less of a driver for us because we already organized several secondary rounds. New investors bought shares from our earliest investors along the way, so there is less urgency to take the company public from that standpoint.

A successful IPO can be a significant awareness-creation event.

Really, the last reason is why we are considering an IPO, which is to use it as an opportunity to raise awareness for the company and better establish the brand. A successful IPO can be a significant awareness-creation event. Millions of people who haven’t heard of us before could discover Lending Club if we would go public, both on the borrower and investor side of things. There’s particularly more synergy on the investor side, with a lot of our existing retail investors being interested in also owning a piece of equity of Lending Club. They want to become shareholders and participate in the growth of the company and industry. It’s also a way for us to reward our customers on both sides (borrowers and investors) by offering them the opportunity to own a piece of the company and benefit from the success they are contributing to.

Are there any companies who have gone public like this, who have had such little need to raise capital or create shareholder liquidity, but simply want more brand-awareness?
We are certainly on one end of that spectrum. I think it is rare to see a company going public as a brand-building exercise, where those first two reasons are not really concerns at all.

It could be helpful since the smaller-dollar investor accounts largely spread through word-of-mouth.
That’s right. It is a lot of free advertising.

Let’s talk about the composition of your investor dollars. At LendIt a year ago, you broke it into 30% retail, 30% high net worth, and 35% institutional. Has that breakdown changed in the past twelve months?
We don’t break it down that granularly – we can share that about 70% of investors on the platform are individual investors, and about 30% institutional.

What is your ideal breakdown of individual versus institutional investors at Lending Club?
I would like direct retail investors to continue to be 25-30% of the platform, with individual investors (whether direct retail or through a fund) to be more than 50% of the platform. The reason for this is that the retail and individual investor base will be more loyal to us, more predictable and more likely to maintain their investments in an economic downturn.

We have a collection of very stable institutions funding our loans.

It is important to state that our institutional investors are not hedge funds, nor are they highly leveraged, which is different from other platforms. We have a collection of very stable institutions funding our loans. However, they are still not as stable as tens of thousands of individual investors making their own individual decisions, the aggregate being very predictable and sticky, which is an incredible asset to us a company.

The public often focuses on the amazing growth of Lending Club’s issued loans, but I’m more interested in the monthly expansion of your retail registrations. How many are active on your platform? How does this number grow period by period?
In 2013 approximately $1.7 billion of the platform’s total originated from individual investors, compared to approximately $713 million in 2012. In 2013, we added about 3,000 individual accounts per month.

How would an online company like Lending Club enter into the more-offline verticals of secured credit, like home mortgages or car loans?
One of our strengths is our ability to operate at a lower cost than the traditional banks. There are many different manifestations of that. First, there is the fact that we do not have a network of branches. This lowers our cost because we operate completely online. Another is our ability to use technology to automate a number of processes that have historically been done manually at the banks, an example being income or employment verification. Banks do register a security like a mortgage using some technology, but it’s mostly manual right now.

We believe Lending Club can create the technology to help automate this and thus do it at a lower cost. That, in turn, will help reinforce the two benefits of Lending Club, the first being a low-cost platform that drives down the cost of credit, and the other being the convenience attached to being an online service.

For example, our income and employment verification not only lowers the cost for us, but it is a better service to consumers. If we verify income through ADP, the payroll processor, it saves our customers the hassle of going through W2s and pay stubs, scanning them, and sending them to us. So I think that is going to be another way that technology lowers cost for us, and also delivers a better experience.

But as an online company, holding a house or car as collateral seems a physical act that requires you to cross from the internet into the real world.
It is partially a physical thing, but you can also register a lien in a more automated fashion. Our ability to automate processes and use technology to lower cost and improve user experience is really going to be the most helpful and transformative in areas that are precisely hard to automate and involve physical documents or goods, like the 4506T process that now allows us to request a copy of tax returns electronically from the IRS, with the borrower’s consent of course.

I filled out a 4506T to get approval for one of your loans.
Right. I think we have been pretty good at transposing offline processes online and automating them. There are a number of touch-points that allow this. For example, some of our requests are generated by direct mail. A customer might receive a physical piece of mail from us that contains a code they can use. They can then type in that code online for a loan. The latest acquisition of Springstone is another example where the initial touch point is the school or the medical care provider.

If, at some point, you need to repossess the house, what does Lending Club have to do? Have employees throughout the country to do this? There seems to be an offline challenge there.
The back end does indeed have challenges. But a repossession, if a loan got to that point, could simply be handled by a service provider. Within the auto industry there is an entire chain of service providers that specialize in repossessing cars, selling them at auction, and then paying off the lenders with the auction proceeds. The banks stay removed from the entire process.

So these industries already exist. We might be able to make them more efficient and consumer-friendly, but in any case, there are already there.

LendingMemo is interested in Lending Club’s ability to simplify and popularize investing, helping more people become their own retirement account managers. Regarding today’s retail investor experience, what do you see average Americans able to do at Lending Club in ten years time?
I think we will continue along the same trend of diversifying the type of credit products that investors have new access to that they did not have access to before, continuing to give them more information and control over their accounts. The future will give them even more transparency and reporting, even more data that allows them to be better managers of their investment.

At some point it’s not crazy to think that we could branch out of credit.

At some point it’s not crazy to think that we could branch out of credit. There are other industries that could be disintermediated, where we could provide a more direct access to investors for an investment opportunity. There are currently some projects we have discovered outside of Lending Club that are trying to apply the same principles of peer lending to the insurance industry. So that is another possible area of expansion.

Overall, I think we are simply going to see further and further expansion into new products and asset classes that give investors the ability to further diversify, finding the right mix of return and risk for their particular situation.

The post Exclusive: CEO Renaud Laplanche on Lending Club’s IPO appeared first on LendingMemo.

A lot has been written about diversification in peer to peer lending, including on this site (see here & here). In short, it is the most important thing investors need to do. Beginner investors sometimes pay too much attention to the details of each individual loan, occasionally forgetting to simply diversify their investment across hundreds of loans. Those who are frustrated by mediocre or negative returns months later, those who feel betrayed, turn, and publicly damn this entire asset class, are almost always investors who simply failed to diversify their initial deposit in enough loans.

The somewhat more debated issue within peer to peer lending has been the threshold at which a portfolio of p2p loans becomes fully diversified. Basically, how many notes does it take? To explore this concept, I reached out to Emmanuel at LendingRobot. He had previously published the below chart that analyzed the completed loan pool at Lending Club.

His data showed the historical crossover point was 146 loans. Basically, (almost) every investor who diversified in 146 equally-valued notes from Lending Club’s pool of completed loans earned a positive return (note: not a guarantee for future performance).

I contacted Emmanuel last month to ask if this point of diversification varied by loan grade. My thinking was that lower risk A-grade loans were probably more stable in their repayments, so the minimum note count to be diversified had probably been historically lower than the other grades. What transpired was a longer email conversation, with the result being the charts seen below.

Probably the most interesting thing this data does is add a bit more nuance to the traditional tenet of 200 notes (Orchard) being the ideal threshold of diversification. As seen in the data below, this number may be overly generous for the safer grades, and too conservative for riskier graded portfolios.

Breakdown of Historical Diversification Points by Loan Grade

Lower Risk Grades

This chart shows that investors who diversified across 60+ completed A-grade loans at Lending Club earned a positive return. This may be incredibly interesting to people like myself who are advocates for others to enter this asset class, since it could offer new investors a much lower trial investment. For some prospective investors, an initial investment of $5000 (200 x $25 notes) is a big pill to swallow. However, if we suggested prospective investors try peer to peer lending with half this amount, perhaps $2,500 (100 x $25 A-grade notes), the trial investment is palatable for a greater number of interested people. Peter Renton actually suggests something similar in his $500 trial investment post.

I imagine the underwriting at Lending Club has improved since these early loans, so this point could be even lower today.

Medium Risk Grades

Here we see the point of positive returns climbing. Within B-grade loans, it is 120 loans. Again, this data indicates that less than 200 notes seems allowed for trial investments as long as a lower degree of risk is taken on.

The overall point of positive returns for all of Lending Club’s completed loans is 146. Finally, in C-grade loans, we have crested this number at 164 and begin to slope downward in any further grades, needing more loans than average for diversification.

Higher Risk Grades

D-grade loans, similar to C-grades, require more loans than average to have an historically positive return: 189.

This is probably my favorite chart of the bunch. Within E-grade loans, we see that 215 notes have been historically required for an overall positive return. This is more than the conventional figure of 200, and points to the fact that diversification is more complicated than typically assumed.

F and G-grade loans never hit a positive minimum threshold. Keep in mind that the note count has also become very low (just 382 & 217 completed loans).

Reflection: Diversification is Complicated

This post really is not a game changer. For new investors who are just starting to invest in online loans, a threshold of 200 notes remains a wise place to begin. However, it seems that prospective investors who are just wanting to try this asset class for a season could open an initial portfolio of fewer notes than 200 – perhaps just 100 equally weighted A-grades, or 150 equally weighted A & B grade notes. Furthermore, if a new investor is focusing solely on higher-risk loans, 200 notes may not be enough. A better idea might be to shoot for an initial investment of 300 notes or more.

Hearty thanks to Emmanuel Marot and the LendingRobot team for providing these figures.

[image credit: Bob Doran "wildchick17.JPG" CC-BY 2.0]

The post When 200 Ain’t Enough: Diversification vs. Risk in P2P Lending appeared first on LendingMemo.

There comes a time in the arc of every investment where things finalize. The money is withdrawn, the account closes, and the funds are placed where they are better put to use.

Peer to peer lending is no different. And while the process of closing a Lending Club or Prosper investor account is certainly more involved than closing a bank account, it’s quite manageable in the general scheme of things. In short, every investor has to do three basic actions:

1. Get back any outstanding principal
2. Transfer the cash into a connected bank account
3. Call Lending Club or Prosper and request the account be closed

Let’s look at these three steps in greater detail. To help illustrate this process, I will be using pictures from a Lending Club account that I closed this week. This taxable account had been liquidated during the Liquidity Project, so it gave me a great opportunity to explore the closing process in full.

Wait or Liquidate? How to Get Back Outstanding Principal

Definitely the most complicated step of the three, there are two approaches you can take to divest yourself from Lending Club and Prosper loans.

Easiest method: Wait for loans to get paid back. This means not reinvesting loan payments into additional notes, but instead logging in once in a while to transfer available cash to your connected bank account. This process is somewhat slow since most loans take three years to be paid back, and many take five years. However, it’s the simplest and easiest of the two options. In 36 to 60 months, you will no longer be a peer to peer investor.

Harder method: Liquidate your account on the Foliofn secondary market. While more complicated, doing this may allow you to get the majority of your invested cash back in just a week or two. Additionally, some investors (including myself) have actually gone on to even earn a small premium while liquidating their accounts. However, doing this needs you to price your loans in a way that sells them, and requires a bit of time.

Setting correct price-points on the secondary market is tricky business. Too low and you have lost potential earnings. Too high and the note may float for weeks with no buyers. To boot, any experience that investors like myself have had may no longer apply since the secondary economy at Lending Club and Prosper changes so quickly. The entire environment is risky and highly speculative (see this disclaimer from Lending Club). While many investors have made a great return there (read NewJerseyGuy’s approach), others have lost money. That said, I think there is a generalized understanding that most healthy notes sell close to par, perhaps with a small markup above or below their current value.

A proper markup is typically determined by a note’s demand. For instance, buyers are usually looking to buy notes with:

• Lower grades (higher interest rates)
• Consistent repayment histories (fewer missed payments)
• Reasonable values ($5000 notes may be difficult to sell)
• Better FICO scores

Basically, the correct initial markup is highly variable, so pricing each note one-by-one is almost impossible to do accurately. A better approach for liquidating an account typically involves an investor casting a wide initial markup and lowering it until every note is gone. This may mean starting more generously (perhaps a 5% markup overall) and lowering this markup (perhaps by 0.25%, 0.5%, or 1%) every few days/hours until the notes are all sold. Some notes may even require sale below par, below a 0% markup, selling them at an overall discount.

Furthermore, investors like myself have sold notes with particularly high interest rates (like E, F, & G grade notes on Lending Club) with a 9 or 10% markup (see my Liquidity Project).  If your overall investment is on the riskier side, you may want to begin above a 5% markup.

Instead of telling you the correct starting markup for your account, which does not exist since every investor’s portfolio is different, I will outline how to sell all your notes once you have identified where you want begin.

8 Steps to Liquidating Your Investor Account

This example will use the Lending Club website, which is currently a lot easier to mass-reprice than Prosper’s. However, the process is generally the same for both.

Step 1. On the main account screen, click on the Trading Account link to enter the Foliofn secondary market.

Step 2. In the main navigation, click the link for Sell Notes.

Step 3. In the Sell Notes area, click the dropdown box on the far right and select All to have all of your notes appear on the screen. Be aware that if your account has hundreds or thousands of notes, your computer may lag a bit as it waits for all of them to load.

Step 4. Check the box on the top left to select all these notes and click the button for Sell Notes.

Step 5. On the pricing screen, click the plus sign (+) until you arrive at the ideal initial markup for your entire account. Again, this will be different for different people based on (1) the loan grades within their portfolio and (2) how quickly they want their notes sold.

Once you have set the markup/discount, click the Submit button. Congrats, all of your notes are now (individually) for sale.

Step 6. Log back in intermittently, decreasing the markup until every loan is sold. You can do this by going into Foliofn and clicking on the My Account link.

Step 7. Check the box on the upper left to select all your notes that are currently for sale and click the blue Reprice button.

Step 8. Lower the markup by clicking the minus sign (-). Click Submit to reprice your notes.

That’s basically it. Just reprice your entire account until every note is gone. The more markup points you choose to use and the more time you give each point, the higher overall markup you may earn. Inversely, the quicker you push it, the less you will generally garner overall. Yes indeed, time is money.

Note #1: Notes with processing payments

This approach has a fairly significant wrinkle. If a note has a payment that is processing, it cannot be sold on the secondary market. So in step 4 above, when you attempt to select all your notes for sale, these notes will not have a box you can check. Instead they look like this (and have the attached pop-up description).

The reason Lending Club restricts these sales is a good one (some sellers had found a loophole to fool buyers into buying junk notes). However, it adds a small complication to the liquidation of a p2p lending account. Basically: any time you reprice your loans at a lower markup (step 6), you may also want to go back to the Sell Notes screen and repost any notes that previously were unable to be sold due to processing payments.

Note #2: Steep discounts may be required for late notes

This entire post is mostly dedicated to helping you sell of notes with a status of Current. However, notes that have gone late will have a slightly different process, mainly in the starting point for the discount you use. To help, here is a chart from Lending Club’s Loan Details section of their Statistics area:

What these pie charts show is the chance a loan will regain its payments and become Current again (for loans over 9 months old) based on the degree of its lateness. Doubly, these percentages can also act as a starting point for discounting late notes. IE: In Grace Period notes typically have a 23% chance of regaining payments and becoming current again. So if you are trying to sell a note that is In Grace Period, you may want to start the discount at 20% and move downward from there. Of course, your result may vary.

As some sort of baseline for all this, explore the Liquidity Project results. I slowly discounted a late note in this project as well and, surprise surprise, it eventually sold at the 49% discount that Lending Club references above. I do not suggest you go crazy in your markup points like I did in that project, but it will hopefully give you a generalized starting place for understanding the Foliofn economy.

Transfer Out All Remaining Funds & Close Account

The last few steps are easy. Once your entire account has been converted to cash, move the funds into a connected bank account so that it looks something like the divested account below.

Finally, contact Lending Club or Prosper account services and have them close your account. To do this, I called Lending Club’s toll-free number for Investor Services: (888) 596-3159. Prosper’s investor line is (877) 646-5922. A few short minutes on the phone with an account manager and your account will close. Afterward, will get an email like this:

[image credit: Charleston's TheDigital "Closed" CC-BY 2.0]

The post How to Liquidate and Close a Lending Club or Prosper Account appeared first on LendingMemo.

While thousands of investors continue to earn great returns at Lending Club and Prosper, the bulk of the country has yet to even hear about it. This is slowly changing as seen in the greater frequency of peer to peer lending being mentioned (Forbes) in major news outlets. And the potential Lending Club IPO (FT.com) may also bring greater awareness. It seems more and more people each day are becoming curious about this new and exciting way to invest.

That said, there is a definite “leap of faith” involved when going from being interested in peer to peer lending to actually investing in it with your own money. For most Americans (typically people in their later years), registering personal information on an unfamiliar website and portioning it with thousands of dollars in trial cash is a fairly large pill to swallow.

To help these prospective investors, I have broken down the average registration and investment process below. Keep in mind that these are simply the basic steps to get a feel for this investment. If you are trying to understand peer to peer lending for the first time, you should instead watch LendingMemo’s video course or read my ebook. On the other hand, if you already have a good feel for peer to peer lending, you may want to forego the 80 A-grade notes and instead invest $5,000 within 200+ loans of your liking.

Note: this article shows the process via Lending Club. However, the process is generally the same on the other equally-deserving platform, Prosper.

5 Steps for a P2P Lending Trial Investment

Step 1: Open an account (free)

The first step is simply to open an investor account with Lending Club (link).

Overall, the application form is very simple and easy to fill out, requiring you to provide typical information like your name, address, and social security number.

You have to provide a few extra pieces of information, including:

• Your state of residence: many states are not yet open to peer to peer lending (like Ohio or Texas).
• Regular or retirement account: retirement accounts (like a Roth IRA) have a different application than regular/taxable accounts. Read: the benefits of a p2p IRA. That said, most people only commit to something like an IRA once they have gotten a feel for this asset class via a regular account.

Step 2: Log in to your account

Once you have completed the application, you can log in using your email address and password. Once logged in, you will see the Account Summary screen below. Next it’s time to connect your bank through the Bank Account link.

Step 3: Connect bank account and add funds to invest

On the Bank Account page you can connect your checking or savings account to Lending Club. Once this is complete, go to the Transfer link and move some money into your account.

Important: the amount you choose to invest will vary by individual, but should be at least $2,000. This will allow you to diversify in 80 lower-risk A-grade notes (80+ notes at $25 per note = $2K). If you want to make a trial investment across all the grades, you will need to transfer over at least $5,000. This will allow diversification across the entire risk spectrum (200+ notes at $25 per note). Read more: the relationship between diversification and risk in p2p lending.

Step 4: Invest $25 in 80+ A-grade notes

Now comes the big moment. If you have at least $2,000 in available cash, click the link for Browse Notes. A large list of available loans will appear on your screen. You are going to invest in a $25 note (or portion) within 80 of these loans.

To find A-grade loans, you will need to sort the available loans by clicking the Rate column. This will cause all the safest A-grade notes (dark blue in color) to appear on your screen. You may want to click the dragdown menu (see right) and select for 250 loans to appear on your screen. Now simply check 80 of these A-grade notes (making sure to invest just $25 in each) and click the blue Add to Order button above. You will now be able to review your order on the View Order page.

If everything is to your liking, you can click Continue to come to the Place Order screen.

Clicking the Place Order button will invest your funds into these loans.

Investing Note 1 – This may take a few days: There may not be 80 A-grade loans available on the platform. When writing this article, there were actually just 58 available. If you do not find 80 A-grade loans (likely), you may need to log back in across a few different days until all your cash is put to work.

Investing Note 2 – Ignore loan descriptions: You can see each loan’s description (borrower profile, credit history, etc.) by clicking on it.

These descriptions, while interesting to read, are unimportant for most beginner investors. This is because all the loans at sites like Lending Club and Prosper are underwritten, meaning each loan has already been filtered by the platforms themselves, so every loan is already likely to be a good investment (particularly A-grade loans). Sometime in the future, you may want to try increasing your returns through filtering your invested loans by different criteria for a marginal performance bump (IE: lending to borrowers with a large annual income). But for now, consider all A-grade loans to be exactly what Lending Club says they are: safer, lower-risk, top-grade investments that can be counted on for a consistent return.

That said, it is a great idea for beginners to read these loan specifics, not to increase returns, but to get a feel for the asset class, to get a feel for these borrowers and for peer to peer lending in general.

Investing Note 3 – With $5,000 or more you can invest in lots of grades: This article emphasizes that you need 80 A-grade notes for a diversified peer to peer lending account. This means a minimum of $2,000 (80*$25=$2K). However, with $5,000+ you can invest in 200 notes (200*$25=$5K) across lots of grades – the safer A-grades through the riskier G-grade loans. Read my article on the relationship of diversification and risk. With $10K, you can bump your note value up to $50 (200*$50=$10K) or $100 notes with $20K. In summary, the most important thing here is diversifying in 200 notes, no matter how large they are.

Step 5 – Reinvest returns

Once this initial deposit is completely invested and 30 days has passed, your borrowers will begin making payments on their loans. These repayments will begin to flow into your account as available cash, and it is your responsibility to invest this cash into additional notes. You can do this by (1) logging in a few times throughout the month to put your cash to work in more A-grade loans, or (2) setting up Automated Investing to do this for you (minimum account $2,500; see picture below). Note: in Automated Investing, be sure to place 100% of your investment in A-grade loans.

Alternatively, you could simply move repayments back into your bank account through the Transfer link. Whatever the case, try and keep available cash as low as possible. Cash drag can be a major factor in lowering your overall return (read more here).

Feel Comfortable with Peer to Peer Lending

The goal of putting a smaller amount like $2,000 to work at a place like Lending Club or Prosper is that this trial investment will allow you to experience 90% of the p2p investor process. You will not interact with loan grades or IRA investing, but you will get a feel for what this entire investment is all about – the large scale lending of money to people over the internet. In short, it will simply help you get acquainted (and even earn you a respectable return in the meantime).

Once you feel comfortable with the safer loan grades, you may want to explore adding additional risk (lower loan grades) so as to boost your overall return. For instance, Jack’s reader story shows an investor who began with safer loans, but eventually added additional risk and found these investments to be even more appealing:

“After one year I switched my strategy to loan grades of C and below, since it seemed people were getting better returns in these riskier loans without a large increase in defaults. On Lending Club I went from an 8% to almost a 10% return in the past 18 months by switching to this strategy.” – Jack (source)

There are actually a lot of ways for investors to increase their returns (see six of them), but many first need to just feel comfortable with this entire thing. If this is the case for you, investing in 80+ A-grade notes should do the trick.

My hope is that you will discover this overall investment to be a peaceful and lucrative way to put your extra money to work, that you will make it part of your life as it has become a part of mine.

[image credit: Felix Montino "Backflip into 4°" CC-BY 2.0]

The post How to Try Peer to Peer Lending (with $2,000) appeared first on LendingMemo.

Each quarter I put my money where my mouth is and post the current state of my personal peer to peer lending investment. I am a investor who enjoys maximizing my return through targetting p2p loans that have the highest interest rates I can find (as well as some minor filtering). While this approach likely boosts my overall return, it also puts me at higher risk for suffering from a rise of any national factors that negatively affect borrowers, such as the national unemployment rate. Most investors, especially those starting out, would probably be better off staying within the more popular A/B/C/D grades.

Caveat aside, you can see in the following table how I continue to celebrate positive returns on both Lending Club and Prosper.

Many Ways to Calculate Returns

Calculating your peer to peer lending return can be difficult. If you want the easy route, both Lending Club and Prosper offer you their measurement, but it can sometimes be inaccurate, especially if you do any trading on their secondary platforms. Calculating your ROI independent of the platforms via XIRR is probably the best solution. Read more about calculating XIRR here.

Introducing LendingMemo’s XIRR calculator

To help investors more accurately measure their returns, I am pleased to share our new XIRR calculator. See picture on the right (hat tip to Pat for his generous code).

Accounts Breakdown

In comparison to last quarter’s returns, my Prosper account return rose slightly, while my Lending Club return dropped 1.5%.

Prosper Taxable Account: 12.70% ROI

This past quarter was just another typical three months for my Prosper investments. I barely checked it. I earned 12%. Life is good.

Lending Club Roth IRA: 11.60% ROI

I was, at first, a bit curious why my Lending Club account return dropped 1.5%. After some digging, I discovered two factors at play. The primary cause was a rise in defaults within the account. This past quarter, I had $540 in additional principal lost to borrowers not paying their loans back, raising the total loss to $1207 (vis-à-vis the previous total of $667).

Secondly, I had just made the $5,000 annual contribution to this IRA in early May. It took three weeks to get this money fully invested (via somewhat strict filters) @ $75/note, and despite some time having passed, almost $4,000 of these loans have yet to make their first payment (see Excel below; the sum of all notes without a payment is indicated by the arrow):

Making a relatively large deposit like $5,000 typically gives a short-term boost to the rate of return (read: the Return Curve). However, it takes a month for most borrowers to begin making their payments, so for the past 6 weeks I have had nearly $5,000 bringing down the overall ROI. The boost of this quarter’s deposit should likely be felt in the coming quarter.

I am keen to see if this year’s Q3 will experience the same degree of lost principal as this past one, considering the default rate theoretically stabilizes after 18 months (and this account is, on average, 13 months old). I’m particularly interested if the typical 18-month return curve is delayed for loans with longer terms, since 88% of the notes within this account are 5-year loans, and my largest jump in defaults actually occurred after the first 10 months.

Some Final Thoughts

This is the seventh post of my personal returns that I have written on LendingMemo, and while my understanding of peer to peer lending has certainly matured in the past two years, I can honestly say my enthusiasm has stayed consistent.

I have embraced passive investing

When I began p2p lending, I enjoyed manually logging into the platforms each day, carefully selling off late notes while meticulously maintaining my filters. I did this because I loved it. It was an empowering experience to self-manage such a novel and tech-based investment. But these days my tack has changed. I am far less gung-ho than I used to be about achieving soaring 12%+ returns, following the lead of investors like Peter Renton into moving from active to passive investing.

This has happened for three reasons. First, I have less time than I used to. Second, selling late notes has largely ended for me (disallowed on both Prosper & Lending Club IRAs). Finally, filtering seems less lucrative than before. Alongside PeerCube’s recent post critiquing fast API investing, I have not seen any hard data demoting the use of filters, but it does generally feel this way. I am studying at UW in order to someday develop my own algorithmic model (similar to Bryce’s approach at P2P-Picks), but while simple filters (IE: Inq=0) still seem worthwhile, they just don’t seem to have to the same punch as they used to.

Peer to peer lending is remarkable

Despite having walked back from the more active angles I just mentioned, I have definitely walked forward into a more holistic appreciation of this investment and all it signifies about how technology is lowering barriers of entry. The short story is that consumer credit, the asset class of simply issuing lines of credit to individuals, is a staggeringly lucrative and consistent investment that is finally available to everyday Americans. Not only does peer to peer lending continue to heartily deserve my own investing dollars (seen above), but it also continues to merit the hours it takes for a site like LendingMemo to play a small part in welcoming its arrival onto the national stage.

Questions/comments?

The post My Returns at Lending Club & Prosper for 2014Q2 – 11.95% ROI appeared first on LendingMemo.

In January of 2013, Aaron and Steve Vermut and Ron Suber faced a impressive task. They had just become managers of a platform called Prosper Marketplace, a company that was a pioneer in the American peer to peer lending space. However, the company was experiencing a number of critical issues that were dragging it downward, so the new team began outlining how to turn the company around.

One of the largest issues in early 2013 was the instability of their current investor base. Without stable funding of their loans, prime-rated borrowers simply would not get their loans funded. More than anything, Prosper needed a reliable institutional investor base. Without it, all of their remaining work would be in vain. To this end, the company turned to Ron Suber.

Suber, a gifted communicator and industrious traveler, packed his bags and got on the road, traveling the nation to listen to what these prospective investors were looking for. At that time, not a single institution was lending through his company. But just twelve months later, Prosper had some of the largest names in American finance as investors on its platform, institutions that ushered fresh stability upon the company, enabling both borrowers to get their loans funded as well as small-dollar investors to have a stable platform in which to place their excess cash.

Recently, I was able to sit down with Ron Suber and talk about how he and his team were able to pull this feat off.

Interview with Prosper President Ron Suber

When you arrived, the company was in a very different place. What were some of the more immediate areas you needed to improve on?
Ron Suber: Clearly, there were many good things about Prosper when we arrived in January of 2013. But one of the main things that needed to change, and change in a hurry, was the brand. The identity, positioning, and design of the company needed a lot of work. Another key thing that had to change was how we acquired borrowers – moving away from this heavy reliance on direct mail and into a more digital marketing and partnership strategy, leaning more into our existing clients and affiliate program.

Aaron Vermut has described in an interview how he arrived to find Prosper sorely needing a stable investor base. Toward this end, what did your original job description look like?
My job description in the very beginning was not to sit at Prosper, but to hit the road and meet with both retail and institutional investors. This largely meant sitting down and listening to what they wanted from us. Many were using other platforms, both personal and business financing, so they could teach us what we needed to do in regard to improving things like the API, data, a bankruptcy remote structure, or setting up a whole loan program, since there was no way to buy a whole loan at Prosper when we arrived.

Notably, there also was this class action lawsuit against Prosper Marketplace by some people who felt they had been wronged. One of our early priorities was to meet with those people, introduce ourselves, and work something out that was good for all parties.

Imagine yourself having just begun your job in early 2013, ready to hit the road. How did you create your first list of prospective institutions to reach out to? Did you just go through your address book?
From my own family office, I was a fairly significant investor at Lending Club and Prosper starting in 2010. I had actually met with the management teams of both organizations, as well as with institutions that were already investing in both of the platforms. Also, my experience on Wall Street for 14 years with Bear Stearns, and working alongside 800 different hedge funds at Merlin with Steve and Aaron, really gave us a head start in terms of knowing the hedge funds, asset managers and family offices, as well as having experience working with them. We traveled around the country to meet with people, from Boston to New Jersey, to New York, to Florida, to the mid-West and all around California.

We had to articulate one key thing, that we had skin in the game too.

Some of these institutions said to us, “We want lower fees” or “We want Prosper to own some of the loans too.” But these were things we were not willing to do. We felt that the fees were fair, and we thought that the platform should not actually own a portion of the loans. So we had to articulate one key thing, that we had skin in the game too, that the management team was shoulder-to-shoulder fully invested in Prosper’s success as well. That was crucial to helping people see our commitment to Prosper’s success, and that it would grow with quality to become a successful and profitable company, like it is today.

When you think about those days, do you remember typing up that initial spreadsheet and getting on the plane to have your first meeting?
I remember flying from Chicago to New York, getting off the plane, and meeting with an incredibly smart $25 billion asset manager who gave me a real education. Candidly, some of these early groups did not invest on the platform for a year. I would stay in touch with them and keep them up to date. Actually, they gave us lots of strategic advice on how to improve the platform. And many of those original people who I met with in the spring and summer of 2013 are now clients of Prosper. It’s been a great relationship from the beginning, improving this company to a point where many became comfortable enough to get on board and invest in the loans.

How did that first meeting end? Did they partner up or take a pass?
The first meeting was an investor with another peer to peer platform, and they were very clear that they would not work with us until we changed certain things. It was actually very educational. I came back to Prosper and met with Aaron and Steve and our team here, and I remember standing up at a white board and drawing a picture. I drew the way Prosper was on the left side, and I drew the picture that these institutions in New York articulated they wanted on the right. And I said that in order for us to get many of these groups on board, we have to get Prosper to look more like the picture on the right, which involved all sorts of different legal, technology, and accounting improvements. So we began to hire people and work with the Prosper team to help us build out that picture.

And today, many of these groups that originally took a pass are now investors at Prosper?
That’s right. Some of them still don’t do business with us, but they want to. We just do not have capacity for all of them at this time. Today, a few of them are very big clients. In fact, one of our earliest clients has recently passed more than $100 million in loans, and is very happy to have been an early partner with us.

Peter Renton has said, “Probably more than anybody in our industry, Suber travels the country spreading the word and evangelizing peer to peer lending.” Just for kicks, how many frequent flier miles did you bank that year?
I am, unfortunately, an Executive Platinum flier with American Airlines.

(laughter)
The flight attendants know exactly what seat I’m sitting in. It’s actually not that glamorous; I flew over 100,000 miles last year. But this was something that had to be done. I had to meet those current and potential clients in person. There was no way around it.

How many prospective investors did you meet? How many signed up?
I met with more than 100 potential investors in those first twelve months. Today, roughly 20 of those groups are investors on the platform in a sizable way. It was really just about building trust. I had a few of these groups to my home, because they wanted to know more about us. Some of them came to the office to observe. Some of them even sent their accounting firms in to audit us, and really came to understand the inside of Prosper, not just our credit model, but how the money flows and technology works. They saw our relationships with the bank where the assets sit, and met with our legal team. The whole process has actually been a lot of fun and a great education.

There must be something really validating about having a major institution look at your company inside and out and choose to partner with you.
One of those early prospective investors from April of 2013 just put their first investment on the platform last month. Today, we laugh about our original meeting in a hotel conference room, about where the industry was back then, and where the platforms were. So much has changed.

It sounds like the majority of these groups took a pass for one reason or another. What were some of the common reasons they gave for not signing up with you?
Some of these early groups were skeptical towards our credit model and underwriting, either through a lack of understanding or trust. Today this has changed because the credit model is performing even better than we had advertised. The actual defaults have been less than what we expected.

Now that we are profitable, I think that is the final answer to people’s previous reluctance.

Another key issue was if we had enough capital to survive. We answered that question with the original money we invested with Sequoia, and then the September financing with Sequoia and BlackRock, and then the financing two months ago with $70 million from three large venture capital and institutional investors. And now that we are profitable, I think that is the final answer to people’s previous reluctance.

How has your job description evolved since you successfully created this investor base?
We think that these online market places for credit are a blend of both retail and institutional investors. We are actually very focused now on adding additional retail investors, even more so than before, so we are working today with some great investment advisors and wealth managers who are helping retail investors gain access to Prosper.

Has your overall work week stayed the same? Will you get on a plane next month to meet with a RIA somewhere, have a cup of coffee and hear their concerns, offering them to get on board?
It’s very similar. It is focused on education, awareness, and understanding of the retail investor, as we first did for the institutions, and then we did for the borrowers. We are working to make it easy for the big wirehouses and other places where retail people are to invest in Prosper loans.

Thinking back to those early days before Prosper’s turnaround was secure, what was one of your earliest celebratory benchmarks?
It was a big day when the first public institution that traded on the New York Stock Exchange became an investor-client at Prosper. Not only would an individual or a private investment partnership want to invest, but a public institution would as well. And then a second one came; the world’s largest asset manager started buying loans from us. And then insurance companies began investing. Then banks.

There was a clear “Aha!” moment at that time that made us realize that we had something special here. If these firms, with all the audits they had done on us from top to bottom, had decided to be clients, we knew this was going to be successful.

Do you remember going out for a celebratory dinner or drink with Aaron and Steve around this time? What did it look like when you got back to San Francisco?
Yes. The three of us met up, sat down together, and came to grips with the magnitude of what was happening. I remember saying to them, “This is even bigger than we originally pictured. This is a mega trend.”

Looking toward Prosper’s future, what excites you about where this company is going?
What really excites me is the opportunity to work with my current teammates and the new people joining Prosper. We have very talented people out of college, people in the middle of their careers and people leaving big successful technology and finance firms with PhDs. There are people coming from all over the world to work with us. I’m excited about the brand new office that we are building for the Prosper team. We hope to move there in December. This is more than work for me; it’s my passion.

The post Exclusive: Ron Suber on Creating a P2P Investor Base from Scratch appeared first on LendingMemo.

These days, midway through 2014, peer to peer lending continues to ride a sensational rate of growth. It took Lending Club five years to cross $1 billion in issued loans. In contrast, $1 billion in loans were issued this past April-June alone. Prosper issued about a third of that volume during the same quarter ($369 million), no small feat. And this growth shows no sign of stopping.

Within the excitement, it can be valuable to take a step back from the hubbub and reflect on why this is a good thing to begin with. The most obvious benefit is the consistent yield it offers. As I’ve described before (Read: Why P2P Lending is Amazing), this is the first time in history that everyday Americans have access to the stable and lucrative returns of consumer credit, a 5-9% return for diversified peer to peer investors. This fact alone is remarkable, and reason enough for many to get involved.

Half a Million (!) Issued Peer to Peer Loans

At the same time, I would like to offer that something more meaningful is going on here, a facet sometimes forgotten by investors only focused on returns. The fact is, peer to peer lending is helping hundreds of thousands of people throughout the nation with their debt, as seen in the chart of total loans below:

Over half a million loans have been issued by Lending Club and Prosper, and 80% of these were used to consolidate burdensome debt. This chart is an amazing reminder that we as investors are earning a solid return by offering borrowers a more reasonable container for the debt they carry, and I’m not sure the investor community is always aware of how significant this is to people, aware of how much a lighter debt instrument can improve a borrower’s quality of life.

The Effects of Poorly Issued Debt

The reality is, burdensome debt is a terrible thing, perhaps one of the worst. In my opinion, stacked against the more acute societal ills in our world today, heavy debt is second only to things like alcoholism.

This article from the New York Times emphasizes this well, highlighting thousands of farmers in India who have committed suicide. Basically, these farmers take out loans to plant crops. But if the crops fail, these over-leveraged farmers are often unable to pay the debt back, and the burden of repayment is so harsh that they take their own lives.

This is a systemic problem for India:

“In the Vidarbha cotton belt, which stretches across central India, to the eastern part of the state of Maharashtra, 451 cotton farmers have killed themselves since the beginning of this harvest; about 2,300 have committed suicide since 2000. Of the 3.4 million cotton farmers in this region, 95 percent are believed to be struggling with heavy debt.”

Or consider this poignant piece from the BBC that reports about how people in Bangladesh can be under such tremendous strain from their loans that they elect to sell their organs in the (misplaced) hope for debt relief:

“Because they cannot repay the loans, there is only one way for people to get out and that is to sell their kidney.”

These articles, though about societies poorer than the United States, do communicate an important point, which is how weighty debt can be upon the lives of the people who carry it. These breadwinners aren’t swallowing pesticides or selling their extra kidney because of some bizarre religious or cultural conviction. No, they are simply struggling beneath their loans.

The Two Characteristics of Poorly Issued Credit

Further, these stories show us how not to issue credit to people; ergo, if a portion of your borrowers are selling their kidneys to make their payments, something is probably wrong with the way you are handing out your loans.

In this regard, I would like to offer two ways that credit is poorly issued:

1. Loans are given to people who are unlikely to repay them
2. People are given loans that are difficult to repay

Bad-practice #1 is really about underwriting. Credit becomes burdensome when it is poorly underwritten – when the people who issue the loans do not adequately assess the creditworthiness of the borrower and thus give a lot of loans to people who will struggle and wilt under the loan’s responsibility.

A good measure of this is the lender’s aggregate rate of default. If a lender is issuing lots of loans, and a large portion of the borrowers go on to default (despite all the prearranged repercussions), both the investors and the borrowers are going to suffer. Not only have the loans gained volatility and a potentially negative return for their investors, but large cross-sections of the borrowers are experiencing the legal and emotional turmoil involved with failing to follow through on their commitment.

Bad-practice #2 is more about the terms of the debt instrument itself. Loans with exorbitant interest rates, loans that punish late-paying borrowers with harsh fees and unnerving variable interest rates, loans that penalize those who wish to pay them back early, are all devices that issuers can use to generate extra revenue. But not only are the lives of the borrowers made significantly worse by these harsh terms, over-reliance upon them indicates that the people issuing the loans have, again, a volatile investment on their hands.

The United States and our Credit Cards

An example of poorly issued debt within the United States has been (surprise, surprise) the way Americans issue and use their credit cards. To summarize our national condition, Americans carry $11.4 trillion in total credit card debt, which comes out to an average of $15,000 per borrower (Debt.org).

Speaking to bad-practice #1 above, many of these credit cards were issued through the lax underwriting of the past decades, so lines of credit were given to people who should not have been approved for them in the first place. Speaking to bad-practice #2, these were revolving lines of credit with variable interest rates of around 15%, which any financial planner will tell you is a pretty poor way to hold on to long-term debt.

Unfortunately, a long-term debt vehicle is what millions of people wanted. So lots of them went into debt who were unable to pay it back, the terms of the debt they took on being incongruent with the way it would be used. The result of this poor match-up was a downward spiral into debt for millions of individual Americans, and a collective degradation of our quality of life as a country.

Indeed, struggling under debt negatively touches every part of person’s life. A parent in deep debt is less able to be a good parent, less able to take time to help their child with homework or attend their school play. A friend in debt is less able to be a present, relaxed friend; a spouse in debt, a less dependable partner.

Saying this plainly in an internet article can come across flat, but if anybody has watched a friend or loved one drowning beneath credit card debt, they know the gravity of this condition. When the focus of someone’s week is completely bent on satisfying creditors, especially if income is already tight, the overall cell of that person and their family can become uncentered. Every aspect of life is made worse.

The Two Characteristics of Excellently Issued Credit

Just as bad loans are characterized by poor underwriting and callous terms, so good loans are properly underwritten alongside fair terms, and this is where our current practice of peer to peer lending shines.

#1. Peer to peer lending has precise underwriting

Unlike credit issuers in the above stories from India or Bangladesh, Lending Club and Prosper have fine-tuned a complex algorithm over the years so as to only issue credit to those who can handle it (defaults around 4%). These platforms only make money on repayments if borrowers stay current on their loans, so they are focused on keeping their default rates as low as possible. The result of this push for lower defaults is a better investment for their lenders, as well as a smaller group of borrowers who are burdened by loans they are unable to repay.

#2. Peer to peer loans are fair to borrowers

Equally notable, peer to peer loans have some of the most reasonable loan terms in the United States. Since they have such low overhead from operating completely online, peer to peer lenders have lower interest rates than anywhere else, and this goes miles in reducing stress during a borrower’s repayment. Furthermore, peer to peer loans have a fixed term and no prepayment penalty. The money can only flow one way, so a borrower can never be tempted to go further into debt. The result is a future payoff date that promises a time when each borrower will be debt free, plus the ability to pay the loan off early without a fee.

Why Peer to Peer Lending is Beautiful

What is the result of all these low interest rate loans given to people who are likely to pay them off? It’s half a million creditworthy Americans who have consolidated their high-interest debt at a more reasonable rate and under more flexible terms. I emailed Lending Club CEO Renaud Laplanche for a metric to emphasize this point. He told me that the average borrower at Lending Club lowers their cost of credit by 29%.

What does it look like when the lives of half a million Americans become 30% lighter? Probably something like this:

• Truck drivers able to spend more time at home with their families
• Dating couples able to spend more quality time together
• Moms able to attend parent-teacher conferences
• Elderly people able to stop cutting pills in half
• Cashiers able to attend community college
• More money donated to charity
• Thicker relationships
• More time for kids
• More health
• Less stress
• Better lives

The word I keep seeing in the list above is able. People able to do more. Ability. Liberty. Freedom.

And this is why I believe is peer to peer lending is beautiful – not just for the way it is making my retirement more of a sure thing, enabling me to spend more time with my future grandchildren, but for the way it is setting thousands of borrowers free.

After all, it is one thing to give more liberty to investors who already possess some degree of it. But a far more significant thing is when an innovation like peer to peer lending shows up with the potential to release a massive cross-section of our country from the burden of debt altogether.

[image credit: skyseeker "parent and child"
vincent desjardins "Farmer"
PTMoney.com "Credit Card Issuers"
Philippe Put "marie stien" CC-BY 2.0]

The post Why Peer to Peer Lending is Beautiful appeared first on LendingMemo.

Getting fully situated as a peer to peer lender can take some time. For one, a prospective investor has to learn the basics of how this entire thing works, how their cash is invested into worthy loans, and how these borrowers then pay these loans back with interest. Second, new investors have to become familiar with one of the two exchanges, getting to know Lending Club or Prosper and the way their websites work. Despite peer to peer lending being somewhat simple as an investment, the typical investor’s initial experience can contain a bit of a learning curve.

That said, once an investor is used to the process, the investment can take on a very different feel. It can almost become boring. Like learning how to drive a car, the initial period may be exciting or stressful, but eventually things settle down. Eventually, peer to peer lending can become kind of dull.

If investing is exciting, you’re doing it wrong.

This isn’t a bad thing. Quite the opposite; it’s an indicator of its inherent stability! There is this great maxim I read that said, “If investing is exciting, you’re doing it wrong.” Our investing, like vacuuming the house or visiting the dentist, should be typified by how important and uneventful it is.

6 Signs You’re a Seasoned Peer to Peer Lender

To illustrate this, here are six signs you have become acclimated to peer to peer lending:

#1. You have automated your investing

For beginner investors, many feel the need to pick their invested loans one by one, reading the descriptions and getting a feel for the people they will lend their money to. I did this myself, at first. But eventually lenders realize that reading each loan is a time consuming process. If they are going to diversify their account in over 200 loans, this would mean reading hundreds and hundreds of loan descriptions. And what makes a good description? Good spelling? A credit history with a low number of late payments?

Seasoned investors are often unaware of the specific loans they have invested in. Indeed, they have often set up Lending Club’s Automated Investing or Prosper’s Automated Quick Invest to place their available cash in more loans automatically, perhaps while using a filter. Seasoned investors typically trust the overall underwriting of the platforms to such a degree that automated investing makes a lot of sense and saves them a ton of time.

#2. You rarely check your investment

When investors start out, they sometimes feel the need to check on their investment every day. This is understandable, as many have never seen a loan payment before, or perhaps are curious what their initial return will be once payments start coming in. And most are curious to see if a borrower will default on his or her loan, particularly how this default will impact their overall return.

But eventually, an investor will experience the full gamut of peer to peer lending. They have loans go late but become current again. They have loans go late and eventually default. Their deposits are invested in loan after loan until they run out. Their ROI initially jumps really high, but eventually settles down as well.

Seasoned investors often have seen it all. With a return that largely remains unchanged from month to month, seasoned investors can go weeks without checking their accounts. For example, I did not check on my personal Prosper investment for over a month until my most recent portfolio update. Yet my ROI was unchanged from last quarter. And this account is only in month 12. Accounts don’t typically stabilize until 18 months have passed, so my most boring months are yet to come.

#3. Your overall return has settled between 5-10%

Early investors experience incredibly high returns. This is because their ROI typically reflects the interest rate of the loans they have invested in, since their loans have not had the chance to default. As the average interest rate on p2p loans is around 14-15%, many investors experience initial returns that mirror this rate.

However, defaults always come, and often in a flurry. That 15% return on month 2 begins to drop, and continues to do so each month for the next year and a half, often stabilizing around month 18 (read: The Return Curve in P2P Lending). New investors can find this process unnerving, especially at first when the drops are the greatest.

Seasoned investors generally don’t experience such precipitous declines in their ROI. Instead, the return on their diversified investment has come to mirror the platform investor average, settling between 5 and 10 percent as seen in the Lending Club graph above.

#4. You opened an IRA with Lending Club or Prosper

For prospective peer to peer investors, their initial trial investment is often some small trial amount in the safest available loans (read: How to Try P2P Lending with $2,000). This allows them to get a feel for peer to peer lending while having the lowest chance of losing money. Many new investors have a great experience with this initial account, going on to invest additional deposits into a wider variety of loan grades.

That said, seasoned investors have come to trust peer to peer lending to such a degree that they open a retirement account at Lending Club or Prosper (read: How to Retire Wealthy with a P2P IRA). These investors realize that p2p lending does not have a special tax rate, unlike capital gains. Considering many stand to lose a third of their investment to these taxes, a tax-incentivized Roth IRA makes a lot of sense, and these investors look forward to withdrawing their earnings tax-free when they turn 60.

#5. You have chosen to take on more risk

Beginner investors can feel uncertainty toward this asset class. After all, investments like stocks and bonds have been around for some time. But peer to peer lending has been around for less than a decade. To combat this lack of familiarity, early investors often choose to fund the safest A-grade or AA-grade loans they can find. Some, like myself, might feel safe enough to make their early investments in C-grade loans, but most stick to the As and Bs.

Seasoned investors, on the other hand, have often shifted to embrace more risk, filling their portfolio with more of the C through G-grade loans. My favorite example of this is Jack’s Reader Story, where he describes his overall return climbing dramatically when he changed his investing strategy from safer to riskier:

“I am happy with my returns since I changed my risk tolerance from ultra-conservative to somewhat aggressive. At that time, we were coming off of the 2008 financial crisis, so I only invested in A and B-grade loans.

After one year, I switched to loan grades of C and below, since it seemed people were getting better returns in these riskier loans without a large increase in defaults. On Lending Club, I went from an 8% to almost a 10% return in the past 18 months by switching to this strategy.”

This does not mean it is right for everyone to take on lots of risk. Many investors, particularly those later on in their lives, experience adequate returns in the safer grades. However, it is quite common for investors to take on more risk as p2p lending becomes more familiar to them.

#6. You’ve given up trying to convince your friends

Many new investors can’t believe how novel and lucrative peer to peer lending is. They are amazed by how simple it feels when compared to a dizzy investment like the stock market. They love its inherent stability and the control it offers them over their own retirement account. These investors sometimes become huge proponents of peer to peer lending. They may talk about it to their friends and family, giving solid reasons why they should adopt it as well.

Seasoned investors have often tried and given up on this errand. While perhaps influencing a friend or two, most investors have realized how difficult it is to change people’s habits, and have instead become content with their own returns. They may hope for p2p lending to become a national trend, influencing their community in ways they themselves are unable to, but until then their investing is largely done independent of their social circle.

P2P Lending: A Cutting-Edge, Lucrative, & Uneventful Investment

Our personal finances provide our lives with a frame, a frame upon which we can fill with people and experiences that make life worth living. This frame is really important. It has to be strong and dependable throughout all of life’s twists and turns. But in the end, it’s just the frame. It is boring to look at, and even more boring to live for.

Peer to peer lending is, at its best, part of that frame. It contains refreshing potential, offering us a stable investment if we do it properly, and this can be seen in the solid yield it continues to offer us. That said, peer to peer lending is largely uneventful once enough time has passed. There are situations where this could change (an increase in unemployment, etc), but largely our experience as investors has been the same year by year.

This uneventful stability is just another indicator of peer to peer lending’s inherent quality, and may be what eventually convinces our country to adopt it as a widespread practice. I believe most investing professionals, including those managing hundreds of employee retirement plans, will be more eager to jump into this asset class once it has had an uneventful 5-10% return for 8-10 years.

What do you think? Did I miss any?

[image credit: Randy Pertiet "Cowboy # 3" CC-BY 2.0]

The post 6 Signs You Might Be a Seasoned Peer to Peer Investor appeared first on LendingMemo.

Much has been said on sites like this one about peer to peer lending’s inherent value for the everyday American investor, particularly its great returns and social benefits. That said, the average person has yet to discover it. Lending Club’s potential IPO may help in this regard, but on the whole, peer to peer lending is still an alternative to the typical avenues that our country uses to put its excess cash to work.

This is changing. Peer to peer lending seems like it is being mentioned in major press with greater frequency each year, yet there has never been a study that showed the rise in this rate numerically.

A quick Google query revealed a report by the Alliance for Audited Media (AAM), a non-profit organization that has tracked the circulation of major newspapers throughout the United States. Below you can see their ranking of the largest 25 (source):

The total circulation of these newspapers is over 14 million. If peer to peer lending is gradually being introduced to average Americans, the evidence would be seen in a growing volume of mentions within this circulation.

Monthly Mentions of Peer to Peer Lending in American Newspapers

To explore this growth, I cataloged every mention of Lending Club, Prosper, or peer to peer lending on the websites of these newspapers for the past four years. This resulted in a list of exactly 200 mentions. Then I noted whether the articles mentioned Lending Club or Prosper (together or on their own), as well if neither was mentioned at all. Arranging these articles by month, I came up with the following chart:

Some items of interest:

1. The skew of the data definitely reveals that the public is being introduced to peer to peer lending with greater frequency. Four years ago, it received an average 1.8 mentions/month, versus an average of 9.9 mentions/month in the past year.
2. Lending Club alone is receiving the majority of these mentions.
3. Newspapers frequently mention Lending Club and Prosper in the same article.
4. The bump outside the curve (May 2013) is the month when Lending Club got press for both its possible IPO and its investment from Google.
5. There has been growth in peer to peer lending being spoken of in the press without a mention of Lending Club or Prosper. This reveals growing interest in peer to peer lending overseas (China, UK, etc) and increased coverage of companies that identify as peer to peer finance, like Funding Circle’s recent coverage in the New York Times.

P2P Stories: The Cream of the Crop

Here are three of the best in-depth articles from the past four years:

• Loans that avoid banks? Maybe not. New York Times: May 5, 2014
• Wall Street Joins the Peer to Peer Loan Party Washington Post: Sept 6, 2013
• Consumers Find Investors Eager To Make ‘Peer-to-Peer’ Loans The Wall Street Journal: Aug 6, 2013

Plus this great piece on a distillery that opened with a peer to peer loan:

• Florida distillery launches premium artisan vodka made of cane sugar Tampa Bay Times: Nov 22, 2012

Final Word: Up and to the Right

If you look at the pages devoted to press coverage at Lending Club and Prosper, they are filled with a variety of great mentions highlighting this new way to borrow and invest. That said, the majority of these “In the News” references are financial sites. It might be an interesting follow-up to this post to explore peer to peer lending’s frequency in financial media. I bet the numbers would be greater and the curve more pronounced.

That said, my hope is for p2p lending to end up in more popular media like our nation’s newspapers, making it part of the way our country lives its life. In that regard, things seem to be off to a great start.

The post The National Rise of Peer to Peer Lending in the Newspaper appeared first on LendingMemo.

In our previous Reader Story, we met Jack, an investor from Illinois who had been p2p investing since 2008. Today we have another solid interview with Jason from Detroit, Michigan. The purpose of these stories is to add a bit of emotion and humanity to this often-dry online investment, helping to further engender trust towards peer to peer lending as a viable investment for everyday Americans.

Since Michigan does not yet allow investors on its primary platform (this should change after Lending Club’s IPO), Jason invests completely through the Lending Club Foliofn secondary market (see Lend Academy). This means his start is a bit more complicated than most, and is thus a more detailed account for us to read today.

This Reader Story is particularly interesting, largely because Jason works in the banking industry. He has a keen sense of how finance works – how investments should be taken on and managed. Jason came to the proper best-practices of peer to peer lending (diversification, risk-tolerance, etc) completely through his own research and expertise, and in this way he speaks with a much-needed fresh perspective.

A screenshot from Jason’s Lending Club account

Interview with Jason: a Foliofn-only Lending Club Investor

Hi Jason. In a sentence, where do you live and what do you do for work?
I live in the Metro Detroit area and am a management consultant in banking.

How did you discover peer to peer lending?
I’ve always been interested in finance and different ways to invest. Wandering through the abyss of the internet, I stumbled upon a blogger experimenting with Lending Club and peer to peer lending. The guy gave an overview and discussed the pros and cons, and I was intrigued.

What convinced you to take the plunge and open an account?
Opening the account wasn’t the hard part, nor was funding the account. It was investing in loans.

I have studied stocks, options, and other investment derivatives and have always had an interest in investing, whether in the stock market, real estate, or otherwise. I have always been interested in ways to make my money work for me rather than always working for money. But when I opened a Lending Club account with $500, I didn’t quite know what to do. I didn’t lose anything, but I certainly didn’t make anything either.  It took me 6 months before I touched the account again.

After some introspection, I realized I was scared and intimidated. I did not fully understand the asset, the platform, or the vast amount of information staring back at me from the computer screen.

I decided I needed to figure it out by putting some money on the line, so I dove in, committing another $1000 and several hours of time. If stock investing taught me anything, I knew diversification was key, not only across credit grades, but also across borrowers. After a quick review of Lending Club’s historical stats, it was clear that I should stick to C-F grade loans and buy no less than 200 mutually exclusive notes (i.e. not originating from the same loan). Sold.

Principal and interest began to trickle into my account day by day. It became exhilarating.

I frantically checked the account every day. Principal and interest began to trickle into my account day by day. It became exhilarating. Every day I could see my earned interest go up. People were paying and paying on time; it was working!

After some time I became comfortable with understanding the secondary market pricing, mark-up rates, yield calculations, and many other factors necessary in evaluating loans to invest in. Within the next 6 months, I went from an asset base of just $500 to over $50,000 (see the graphic above).

What is your return today? Are you happy with it?
I invest on Lending Club’s Foliofn secondary market due to the fact that I reside in Michigan. After about 9 months of investing, my Lending Club calculated NAR is approximately 15%, and around 10.2% as calculated with the XIRR methodology (as recommended by LendingMemo.com).

In order to maximize my returns, I implement a few strategies that I refer to as:

• Targeted Filtering (how I buy notes)
• Proactive Portfolio Management (how I hold/sell notes)

For Targeted Filtering, I focus on five main things:

1. Yield: greater than or equal to 17%
2. Loan term: 60 months
3. Markup: 1% or less
4. Remaining payments: 54-60 months
5. Note value: $150 or less

First, a high yield ensures a good return. The difference between yield and interest rate (APR) is that once a loan has been issued and has begun to repay the debt, the effective interest rate changes; this is its yield. A high yield means high returns.

The second is a note’s term. In general, 60-month loans carry a higher interest rate. Additionally, 60 months gives the borrower more runway to make their payments.

Third is a note’s markup. Markup is the premium you pay to buy a loan. Simply put, you don’t want to pay money; you want to earn money.

Fourth is the number of remaining payments. In my experience, it is better to hold a young loan because I assume the borrower is prepared to begin making payments immediately. As time goes on, it becomes more likely that the borrower’s circumstances change and they are unlikely to repay.

Fifth is the note’s value. Generally you want to keep this to 1% or less of your portfolio, but for me, I don’t like the idea of losing more than $150 on any one borrower in the case they do in fact default.

Regarding my Proactive Portfolio Management, the analytical engineer in me got a little carried away and build an Access database in which I am able to download Lending Club data and query loans based on my criteria [Ed: awesome].

In particular, I focus on four key areas:

1. Months elapsed: I sell off anything older than 15 months.
2. Note exposure: I ensure that any one note does not represent more than 1% of my portfolio; diversification is key.
3. Ability to repay: I calculate the borrower’s loan payment to monthly income ratio, review their DTI and income, and with that in mind, make a decision to sell or hold; this one is more of a gut check.
4. Inquiries & loan purpose: Compliments of LendingMemo.com, I’ve recently begun to consider the number of credit inquires and loan purpose in my queries to further filter out potentially problematic loans.

What does your family or friends think of your investment?
I have only shared this with a few people. Some seem interested, yet hesitant. My guess is because it’s a fairly new asset class and is unfamiliar to them.

Has anything been disappointing or unexpected?
The only disappointment as of now is the limited number of states from which you can invest. I’m in Michigan, so I’m limited to the Foliofn platform. Don’t get me wrong, I love the secondary market. However, I would also like to use the main Lending Club platform and tools.

What would you say is the best part about peer to peer lending?
The three best reasons are the ease of access, the low transaction costs, and the predictability.

In reflecting on my stock market investing, I find peer to peer lending far more straightforward. Investing in stocks tends to require hours of research, comparing P/E ratios, following market trends, and even after all of that it still feels like a crap-shoot. The volatility alone is not for the faint of heart.

With peer lending, you know what you’re getting and it is relatively predictable.

But with peer lending, you know what you’re getting and it is relatively predictable. You buy a loan and the borrower pays you back at a fixed rate for a fixed term. It is all pretty straight forward. The market is governed by only a handful of parameters, compared to the stock market, which is affected by far more variables.

Obviously peer lending is not without its risks. People default and life happens. But peer lending is simply a numbers game; diversify broadly, target credit bands, manage appropriately, and you should have a fairly good chance at generating a solid return.

Thanks Jason.

Share Your Story (and Get Coffee by Mail)

Getting spotlighted on LendingMemo is simple (and comes with a bag of Stumptown). Just answer the following questions:

1. In a sentence, introduce yourself, your family, where you live, and what you do for work.
2. How did you discover peer to peer lending?
3. What convinced you to take the plunge and open an account?
4. What is your return today? Are you happy with it?
5. What does your family or friends think of your investment?
6. Has anything been disappointing or unexpected?
7. What would you say is the best part about peer to peer lending?

Email your answers to readerstories (at) lendingmemo.com with (1) a picture of you or your family and (2) a screenshot of your Lending Club or Prosper home screen. Bonus points if you’re of retirement age – we need more of you.

Indeed, the national climate will change through stories like these. If you care about spreading the word of p2p lending, let’s hear from you!

The post Reader Story #4: Meet Jason, a Foliofn Investor from Detroit appeared first on LendingMemo.

On Wednesday morning, something remarkable happened. Lending Club filed this S-1 form with the SEC, their first official step towards having an IPO and becoming a public company that trades on the US stock market. The filing marks an historic moment for their company and peer to peer lending in general. What an exciting time this is.

A hundred media outlets immediately sprang to cover the IPO filing over the next few days, with the New York Times being first to break the story around 1:30pm EST. A key quote from their article was:

“Lending Club listed $500 million as a preliminary fund-raising target — but it could seek to raise even more, according to a person briefed on the matter. That initial goal would still be enough to rank the prospective public offering as one of the 10 biggest stock market debuts of an Internet company.”

What the Times is referring to is the section from the Lending Club S-1 form labeled Calculation of Registration Fee that states their “Proposed Maximum Aggregate Offering Price” as $500 million:

This number, a measurement for the IPOs size, is indeed remarkable, especially when held up against other companies that have gone public in the past.

Largest 10 US Internet IPOs (initial public offerings):

1. Facebook – $16B (billion)
2. Twitter – $2.1B
3. Google – $1.92B
4. Genuity – $1.91B
5. Zynga – $1B
6. Groupon – $805M (million)
7. Vonage – $531M
8. Orbitz – $510M
9. Compuserve – $480M
10. Savvis Communications – $408M (source: A, B, & C)

Not only is Lending Club likely to be the first public p2p lending platform, but they may go public in one of the largest IPOs for an internet company in American history. The New York Times piece continued on with this juicy detail:

“Anticipation over Lending Club’s impending I.P.O. had been so high that many of Wall Street’s biggest investment banks battled to claim a piece. The filing disclosed that the stock sale will be led by Morgan Stanley and Goldman Sachs.”

We have come a long way since the institution-empty days of 2010. Not only are major financial players no longer wary of Lending Club’s history and business model, they’re actually fighting each other over who gets to be involved with their success, with the winners being the most dominant financial firms in the country.

Bloomberg reflected on the IPO as well, and had this to say:

“The peer-to-peer lender’s valuation reached almost $3.8 billion in April, a 63 percent jump from November, people familiar with the matter said then. At that level, LendingClub’s market value would be higher than 97 percent of banks listed on U.S. exchanges.”

On a similar note, the London-based Financial Times concluded that Lending Club is “likely to seek a valuation of about $5 billion” (source; emphasis mine).

In summary, Lending Club has officially filed to become a public company. Their paperwork shows that they intend to make history in 2014: a $500 million IPO and $5 billion valuation would be an enormous national headline, and could further position Lending Club as a prospective staple of American society. As Peter Renton has said, “Lending Club is positioning itself not just as an online platform but as the financial services company of the 21st century.”

Before Lending Club Joins the Stock Market: a Checklist

The company has now gone into a “quiet period” where they are forbidden to promote their IPO (read: Google IPO and Playboy interview). As outlined in this Quora Q&A (hat tip to Bo Brustkern), there are a few short steps remaining in the process before Lending Club gets a ticker symbol.

• The SEC begins an exam of Lending Club and their S-1, and will send back a list of detailed comments. This can take 30 days.
• The company and the SEC then go back and forth with responses and further comments until everything is kosher. This may take 2-3 weeks, but can take longer if things get bogged down.
• As this completes, Lending Club goes on a two-week roadshow (Wikipedia) where they travel the country, meeting with institutions and inviting them to take on a long-term stake in the company.
• If they feel they have garnered $500 million worth of interest and the US stock market conditions are favorable (versus this IPO story from WSJ), then barring any unforeseen issues the stock’s price will be announced and it will open for trading on either the NYSE or NASDAQ (my guess: the NYSE).

Lending Club is set for a mid-November IPO

The entire process often takes 10-12 weeks, which would position the IPO to happen between the 6th and 20th of November. This date jives with a confidential source of CNBC’s Ari Levy that said:

“If the stock market behaves, LendingClub plans to go public before the Thanksgiving holiday in late November.” Lending Club IPO to reward Silicon Valley approach

There are a number of issues that could complicate things. First and foremost, Lending Club is trail-blazing a brand new industry, so the SEC may take extra steps to ensure everything is in order, which could mean a longer regulatory dialog. Additionally, there are a variety of assorted variables that all have to line up for this to happen. An IPO is sort of like a wedding where a hundred parties attempt to unify around one date on the calendar. If bad press or a Thanksgiving holiday gets in the way, things can get delayed.

Since Lending Club is a harbinger for future peer to peer IPOs, Prosper being next, I imagine there will be a more intentional dialog with the SEC. That said, I do not really foresee any major setbacks. Even as a private company, Lending Club has been working with the SEC for years; they have already been publicly transparent for a long time. In my eyes, the major issues were put to rest years ago, so a smooth IPO should indeed happen in mid-November.

What this Means for the United States

This IPO could mean very little or a great deal to the country at large. On the one hand, another big-dollar Silicon Valley company having an IPO and trading on the stock market does not typically affect the lives of most people. Dozens of major press outlets gushing with all this “$500 million”-laden vernacular can make it seem like we just discovered the cure for cancer, when in actuality, life a year from now will look pretty much the same as it does today.

Of the two things Wall Street is good at, one is getting the media to clap in unison and make things meaningful when, in fact, they aren’t. That said, the other thing Wall Street does quite well is provide a national stage that can spotlight amazing companies and reward them for their hard work and ingenuity.

Lending Club is one of these amazing companies. Launching in May of 2007, it took them five years to figure out their model and reach $1 billion in issued loans. In comparison, the company today is issuing over $1 billion in loans every three months:

This growth is at just a fraction of where it could eventually go. The Wall Street Journal said that this current total of $5 billion issued loans is just 1.3% of what’s possible:

“Lending Club cites the size of the overall consumer credit market at $3.2 trillion in the filing and said that roughly $380 billion of that would qualify under its relatively stringent qualifications for borrowers.” Lending Club: A Look Inside its IPO Filing – WSJ.com

In this way, an IPO on Wall Street is a moment for Lending Club to shine, highlighting the hard work and thoughtful product that has been created by Renaud Laplanche and his team. It is a huge opportunity for the entire country to discover peer to peer lending for the first time. Large scale lending of money through the internet is an inexorable future way of life for our country, and Wall Street is one of the avenues this innovation must pass through to make that transformation complete.

In my favorite section of the S-1 filing, Laplanche wrote a letter where he explained the heart of his company and why this is all possible. The best paragraph of this letter, titled It Feels Good to Share, is printed in full below:

“The sharing economy that emerged after the 2008 financial crisis was initially motivated by financial considerations and the economic efficiency derived from putting underutilized assets to better use. I believe the sharing economy has now given birth to a socially desirable way of life that is gaining ground in every aspect of our lives from transportation and hospitality to financial transactions, with money being one of the most underutilized assets. I believe the reason our users choose Lending Club goes beyond the desire to obtain a better deal or a better experience than they’re getting from their bank. There is strong satisfaction in investing in people and having them invest in you.”

This, I think, is the foundational driver of Lending Club’s success. Lower interest rates and solid returns are a natural extension of the good relationship that forms when we directly connect those of us who need a loan to those of us who have extra to lend.

3 Ways an IPO Helps Lending Club as a Company

There are a number of big ways this IPO benefits the company. In his June interview with LendingMemo, Laplanche stated the big three as:

1. National attention
2. Shareholder liquidity
3. An influx of capital

In our interview, Laplanche emphasized the publicity element as the sole reason Lending Club seeks an IPO:

A successful IPO can be a significant awareness-creation event. Millions of people who haven’t heard of us before could discover Lending Club if we would go public, both on the borrower and investor side of things.

This is worth reemphasizing. The fact remains that the majority of Americans have never heard of Lending Club, and a foot-stomping confetti-raining moment at the center of American finance would go miles in helping that situation. As Lending Club is referenced over and over in national media, more and more people will choose to borrow and invest through their platform.

However, I think the other two reasons are helpful to Lending Club as well. Speaking towards shareholder liquidity, I would not count this one out. There may still be a number of their earliest investors who want to have an exit. Secondly, Lending Club may not critically need a $500 million bag of cash, but it would enable them to do some creative things in the coming year. They could purchase another company. They could buy a Superbowl ad. They could mail a bar of chocolate to every household in America that says, “What tastes better than chocolate? Being debt free.” After all, this is more than the $392m they have raised in the entire history of their company (Crunchbase).

3 Ways an IPO Helps Peer to Peer Investors

This IPO offers a number of huge benefits to all of us who invest in peer to peer loans:

1. The blue sky exemption
2. A better investment
3. A better investing process

As stated previously, going public as a company would open up the remaining 23 states in the US that do not allow investing at Lending Club. This includes enormous concentrations of the country, like the states of Texas and Ohio. An IPO would mean that Lending Club needs solely federal approval to operate nationwide; fickle state regulators in Ohio would no longer have any say. Millions of Americans, including my parents in Michigan, could finally become Lending Club investors.

Secondly, an IPO would make Lending Club a better investment. One of the risks around Lending Club, as previously highlighted at LendingMemo, is that a platform could go bankrupt. Investors would surely be impacted by such an event, though how badly is debatable. An IPO would further bolster the future of this company and push the possibility of a bankruptcy even further away than it already is.

Finally, a Lending Club IPO could result in a better investing experience. With $500 million in cash, Lending Club could further improve its website’s architecture and design to make investing an easier and more pleasurable experience.

The Future of Everyday Finance is Bright

This has been a huge week for peer to peer lending. The name of our largest platform has been splashed across a hundred major news outlets. The most prominent voices in the US are hailing Lending Club as one of our nation’s brightest points of innovation and progress. The shareable economy continues on in its unstoppable descent, this time in a company that directly connects the nation’s debt to its investing.

What happens next is both uncertain and very exciting. Will the SEC give Lending Club the green light? Will Wall Street see them as a company worthy to buy-and-hold? Will Lending Club’s IPO finally make the country sit up and pay attention to this wonderful way to invest and borrow money from one another?

I believe it will. Person to person lending is a natural extension of the phenomenon that is already happening throughout the world, where technology is patiently superseding the inefficient brick and mortar of the past. Lending Club going public in November would simply be a moment where that wider transformation suddenly concentrates and becomes very obvious.

[image credit: Dan McKay "New York Stock Exchange" CC-BY 2.0]

The post What Making History Looks Like: Lending Club Files for IPO appeared first on LendingMemo.

People looking for a way to safely invest their extra cash should consider Lending Club. Since its launch in mid-2007, the peer to peer lender has paid over $540 million to tens of thousands of investors, with most people earning a 5-10% return per year. The company continues to experience over 100% annual growth, and is regularly mentioned in major news outlets as one of the most promising companies in America (Forbes).

Today we will review the investor side of Lending Club – how it works, what to expect, and how to get started. Let’s begin.

What is Lending Club? An Overview of Peer to Peer Lending

What Lending Club does is quite simple. They use the internet to connect people who need a loan with people who have extra money to lend. The term for this type of lending is called peer to peer lending, and it is brand new to the way America thinks about its finances. In short, it is loans without the banks. Instead of a borrower parking their car at Chase Bank and walking through the door to apply for a loan, they turn to a website like Lending Club. Since Lending Club cuts out this bank and operates online, it can pass the savings over to the customer, giving these borrowers a lower interest rate than anywhere else.

Peer to peer lending is the crowdfunding of loans over the internet.

As an investor, you earn a return by lending your extra cash to these creditworthy borrowers. You do this by investing in notes, or $25 portions each loan. This way you can spread (diversify) your investment across hundreds of loans, while the borrowers can have loans (up to $35,000) funded by hundreds of different investors. In short, peer to peer lending is the crowdfunding of loans over the internet.

Note: Some people cannot invest money at Lending Club

Not every investor is currently eligible to lend money through Lending Club. There are a few requirements that you have to meet when you open an account. For instance, you must live in one of the eligible states:

The reason for this scattered map is that Lending Club investments have legally been classified by the SEC as securities. As a result, Lending Club has had to approach the regulators of every state one by one for approval, and some are not yet on board.

Live in a state open to Lending Club?
Click to open an account (free).

3 Great Reasons to Invest at Lending Club

If tens of thousands of individual investors are moving their excess cash to Lending Club, the company must be doing something right. LendingMemo polled our readership to ask why they invest. Here are three of the most common answers:

#1. Returns of 5-10% per year

The main reason people come to Lending Club is the return it gives them on their invested cash. The loans they fund typically have a 14% interest rate. Minus a 4-5% default rate plus 1% given to Lending Club in fees, that leaves most investors with an 8% return by the time their account matures (14% minus 6% = 8%).

Many Americans typically keep their extra cash in a savings account. What is the average rate on a savings account in the United States? Around 0.5% (source), a fraction of the return that most peer to peer investors are earning.

#2. A consistent investment

Even in a recession, peer to peer loans are a good investment. During 2008, the national economy experienced the worst financial fall since the Great Depression. During that same year, Lending Club still managed to return investors 3% overall.

How is this possible? In short, peer to peer loans are less tied to the stock market than most traditional investments. They are issued to prime-rated borrowers who are remarkably consistent in their repayments, even in tough times.

#3. Peer to peer lending just makes sense

Investing in the stock market can be confusing, and it is difficult to see your money helping anybody. But investors at Lending Club often feel good about their investment because it is being used to help people get out of credit card debt. Over 80% of the borrowers at Lending Club are people consolidating their debts at a lower rate.

In short, peer to peer lending is really simple to understand. People need help getting out of debt, so you lend them the money to make that happen, earning interest in the process.

Investing at Lending Club Does Involve Risk

While there are great reasons to invest at Lending Club, there are risks as well:

Risk #1. Defaulting loans (most common)

The biggest risk that you take on as an investor at Lending Club is a loss of your investment to defaults, a ‘default’ being a loan that a borrower has failed to pay back. New investors be aware: these are unsecured debts. They are not secured by a house or any sort of collateral. If your borrowers want to declare bankruptcy, they can. You would then lose everything you had invested with them.

Spread your investment across at least 200 loans.

To combat this, we diversify our investment. The most important thing in peer to peer lending is to spread your investment across at least 200 loans. Since the smallest portion of a loan you can invest in is $25, this means most investors need to start with $5,000. Investing in 200 loans will likely keep your default rate at a reasonable and consistent level. LendingMemo did a study last year, and found that just 4 out of 3800 diversified investors had lost money.

There are a few exceptional circumstances that could increase this default rate. For instance, if the national economy fell apart and the unemployment rate shot up, Lending Club’s default rate would likely go up as well.

Risk #2. Rising interest rates (less likely)

A rise in the national interest rate could affect Lending Club’s business model. After all, if investors can get a risk-free 6% return in a savings account, why would they earn 6% with borrowers who might default on their loans? A high-interest rate environment would definitely impact investors. That said, I think peer to peer lending would simply adjust to this reality. Lending Club might struggle to get investors for lower-risk loans that earn 5-6%, but there would still be demand for medium-risk loans that return 7-10%.

Risk #3. Underwriting degradation (unlikely)

We are dependent upon peer to peer lending platforms like Lending Club to underwrite all of our loans, making sure that our money is only lent out to creditworthy individuals. If they suddenly lowered their minimum credit score for a loan to 550 (currently it’s 660) because they needed a larger supply of borrowers, investors would certainly have a higher rate of default and a potentially worse investment.

This is something to keep in mind, but it isn’t huge. Since all Lending Club loan data is available for people to download, many statisticians watch it to ensure borrower standards are kept high. On the contrary, Lending Club’s overall default rate has actually gone down each year (see chart above), so the underwriting is actually improving.

Risk #4. Lending Club may go bankrupt (unlikely)

In case of a bankruptcy, a backup servicer is in place to funnel borrower payments to investors. That said, there has never been a peer to peer lender bankruptcy before, so we do not really know what would happen. In a worse case scenario, lenders might lose large portions of their investment to satisfy the company’s creditors.

However, Lending Club has experienced such phenomenal success that this is less of a concern today than it has ever been. When the company was brand new, this was an often cited risk. Today, few are worried about it.

Risk #5. Unforeseen risks

Unlike stocks or bonds, where we have a hundred years of history to look at, peer to peer lending is less than a decade old, so there are a variety of unknowns that could impact us. Lending Club is still a young company that evolves and changes each year. This is a good reason to subscribe to the monthly LendingMemo newsletter so as to keep tabs on the industry.

The Most Important Thing: Diversification

As I mentioned in Risk #1, the most common reason that new investors experience poor or negative returns at Lending Club is because they do not diversify in enough loans. If you want to begin investing, you should seriously consider spreading your cash across 200+ equally-weighted notes. Since the minimum loan portion at Lending Club is $25, this means every investor should be starting with $5,000 (200 x $25 = $5,000). You can invest using larger portions — just make sure you have 200 notes. People with $10,000 to invest could use $50 notes; people with $50,000 could use $250 notes, etc.

You may be able to invest with just $2,000 (80 notes), but you must only invest in the safest A-grade loans. Read: How to Try Peer to Peer Lending with $2,000

Investing on Lending Club: A Walkthrough

Now that we have explored the benefits and risks of Lending Club, all that’s left is to take a look at their website. Let’s do that now:

Screen #1. The main account page

This is my personal IRA at Lending Club, and is an example of the main account page for every investor. The most important information is layered here, with a focus on three big numbers:

1. The account’s return (see above: 13.44%)
2. Current value (above: $18,543)
3. Earned interest (above: $4,665)

These three numbers are followed by other important figures, such as the amount of available cash in my account as well as the status of all my invested notes. In this example, you can see I have 462 notes that are healthy, 35 notes that have defaulted (charged-off), and a variety of loans in various stages of lateness.

Note: I am not actually earning 13%, as the graphic seems to indicate. I have traded on the secondary market, which makes my account page inaccurate. My actual return, calculated via XIRR( ) in Excel, is around 11%.

Screen #2. Lending Club’s list of available loans

Clicking on the Browse Notes link in the previous picture would bring us to this screen:

Click to enlarge

On the Browse Notes screen you can see all the loans currently available for investment at Lending Club. Each one of these loans represents a prime borrower who has passed Lending Club’s credit standards.

In this example, the number in the upper right (see the arrow) shows that 324 loans are currently available for investment. We can sort and filter this list of available notes by different criteria to find the investment that is right for each of us.

Loan Grades (A through G): The factor most investors pay attention to is the Rate column, indicated in the picture by the colored boxes. Lending Club has seven loan grades (blue As are the safest – orange Gs are the riskiest), and each grade measures that loans risk. While all the loans at Lending Club are for creditworthy borrowers, every loan can still default, and some loans default more often than others. The amount of risk we invest in has a strong effect on our accounts overall return. For example, I personally invest in riskier loans (grades D-G) and that approach has earned me over 10% per year. Others stick with safer A-grades and earn a respectable 5% return.

Screen #3. The automated investing tool

Choosing individual loans one by one can become quite time consuming. Most investors, including myself, have instead chosen to automate our investment at Lending Club using their Automated Investing tool.

Click to enlarge

This tool makes investing at Lending Club a snap. After selecting your ideal mix of loan grades (risk) and note size ($25 for most), you can set the tool to automatically invest in loans for you. Personally speaking, each day I receive an email from Lending Club’s automated tool telling me they have invested in notes that meet my criteria. Sometimes I go to the Lending Club website and check my returns to see how they are doing, but there is usually no need to do this. Automated investing at Lending Club has made my investment a nearly hands-off experience.

Screen #4. The notes page

Click to enlarge

Anytime you want to see your individual loan investments, you can navigate to the Notes tab. Here you can get a bird’s eye view of your account, place loans into portfolios, and click on each loan to see that loan’s details. If you see a large portion of loans defaulting, you might examine them one by one to see if they have something in common – informing your investment strategy in the future.

Choosing Your Risk Tolerance (and Retirement Account)

As mentioned earlier in this post, there are different degrees of risk you can take on as a Lending Club investor. You could go the safer route and invest in just A and B-grade loans. Or you could copy what most investors do: spread your investment across all the different loan grades for a balance of risk and return.

The degree of risk you take on will impact your overall return. As see in the chart on the right, borrowers pay just 6% for an A-grade loan. After defaults and fees, you may earn around 5% on these loans. However, if you invest in riskier loans like D-grades, borrowers are paying 17-20% on these loans. After defaults and fees, you may earn closer to 8-10%. I am younger and without children, so I prefer to take on more risk. But, for example, if you are close to retirement, you may want to invest in the safer lower-risk grades. These loans have lower volatility; there is some evidence that shows safer A-grade loans being less impacted by negative factors like a rise in national unemployment.

Lending Club IRAs and 401(k) Rollovers

Eventually, you may even choose to invest through a Lending Club retirement account. Since peer to peer lending does not have any tax advantages (unlike capital gains taxation in the stock market), you will pay the same taxes on this investment that you would on interest earned through a savings account at a bank. For some, this can mean 30% of some investors earnings are lost to taxation. Do everything you can to avoid this factor. Investing through a Lending Club Roth IRA means you could eventually withdrawal your earnings completely tax-free!

Final Word: A Lucrative & Solid Investment

The internet has changed many parts of our lives. Almost nobody uses movie rental stores anymore; we get them at home through low-cost Netflix. Almost nobody sends letters through the post office anymore; we send no-cost emails. Investing through Lending Club is the next step for our retirement accounts. We won’t be using brick-and-mortar banks to invest. Instead, we will be investing online through low-cost companies like Lending Club.

This is the first time in American history that we have the ability to invest money to one another on a national scale. Considering the borrowers are prime-rated, creditworthy individuals who almost always pay their loans back on time, considering this investment is so simple to understand and excel at, I believe you will discover Lending Club to be one of the most rewarding investments in your portfolio.

Try Lending Club and see for yourself.
Click to open an account.

[image credit: Bob Doran "wildchick17.JPG" CC-BY 2.0]

The post Lending Club Investor Review: Invest in Loans, Earn 5-10% appeared first on LendingMemo.

People looking for a solid way to invest their extra cash should consider Prosper. Since 2006, they have paid over $140 million to their investors, with most people earning a return of 5-10% per year. Prosper has quadrupled in size in the past twelve months alone, and is frequently cited in American media as one of the fastest growing companies in the nation.

Today we will review the investor side of Prosper — highlighting both how the company works as well as how you can get involved. Let’s get started.

Peer to Peer Lending: The Heart of Prosper

As a company, all Prosper does is connect people looking for a loan to people with cash to invest. Basically, it is lending without banks. This kind of lending is called peer to peer lending (Wikipedia).

As a peer to peer lender, Prosper is completely based online. They don’t have to pay for vaults or tellers like banks do, and can pass the savings over to their users. The result for borrowers is a cheaper interest rate at Prosper than anywhere else – as low as 6.7%.

Since the bank is cut out, borrowers get low loan rates and lenders get a great investment.

Investors are more than happy to earn 5-10% per year by investing in these loans. We do this by investing in a small $25 portion of each loan, called a note. This allows us to spread our dollars across hundreds of different borrowers and remain diversified, while borrowers can have loans funded by hundreds of different investors. Basically, since the bank is cut out, borrowers get low loan rates and lenders get a great investment.

This is what peer to peer lending looks like:

1. You transfer a lump sum to Prosper and invest in 200+ notes
2. Borrowers pay these loans back each month with interest
3. You take these repayments and invest in more notes

Simple.

Are you Eligible? The Prosper Investor Map

To invest at Prosper, there are a few requirements you have to meet. For example, you have to live in a state that is open to investing:

Since peer to peer investments are classified as securities, has to approach every state individually for approval. Some states are not yet on board, so you can see a number of holes in the above graphic.

Live in a Prosper state?
Click to open an account (free).

3 Great Reasons to Invest at Prosper

LendingMemo surveyed our readers last year to ask why they like peer to peer lending. They gave three main reasons.

Reason #1 – Prosper returns investors 5-10% per year

The biggest reason people lend money at Prosper is for the return they stand to make on their invested cash. Borrowers at Prosper typically have an interest rate of 14% on their loans. Around 4-5% is typically lost to defaults, and another 1 percent is paid in fees. This means most investors earn an 8% return per year by the time their investment fully matures (14% interest rate – 6% defaults/fees = 8% overall). This return actually spans 5-10% depending on how much risk you take on.

Where are most Americans keeping their extra cash? In a savings account where it earns a tiny 0.6% per year (see CNN Money). This isn’t to say savings accounts are bad. After all, they are 99.9% risk-free and easy to withdrawal cash from, which can be really good for things like an emergency fund.

That said, a savings account can be a poor place to park cash long-term. Let’s say you placed $10,000 in a savings account for a full year. It would grow by just $60. In contrast, that same amount in a 8% Prosper account may have earned you $800 — a difference of $740.

Reason #2 – Prosper investments are trustworthy

Prosper lends your cash to prime-rated borrowers, meaning people with good credit history who are likely to pay back their debts. For instance, the average credit score of borrowers at Prosper is 700. This makes them remarkably stable compared to many traditional investments.

The stock market, for instance, is famous for the way it can rise and fall without warning. If the Dow Jones Industrial Average suddenly loses a lot of value, Prosper loans are less affected than other investments. The reason for this consistency is the container that is holding our money, that being, people who are responsible. While companies on the stock market can rise and fall, responsible individuals around the country are amazingly consistent with their repayments.

Reason #3 – Peer to peer lending is simple and good

Learning about investing in stocks or bonds can be really confusing. And it can be hard to see how many traditional investments are doing any good for others.

But peer to peer lending is great in both these areas. First, it is easy to understand. You just (1) help give loans to people, and then (2) they pay them back. Simple. Secondly, 80% of the loans at Prosper are for people consolidating their debt at a lower rate, like people cutting up 3-4 credit cards (each with a crazy 20% interest rate) and combining the debt into one easy Prosper loan at 14%. Basically, we are helping people get out of debt while saving for our own retirement. It’s win-win for everybody involved.

4 Risks of Investing at Prosper

While Prosper is a great way to invest, there remain a number of risks to be aware of:

#1: Borrowers default on their loans (more common)

The most common risk in peer to peer lending is losing a large portion of your investment to borrowers who fail to pay their loans back. When this happens to a loan, it is called a default.

Every new investor needs to realize that these are loans are not secured by a house or any collateral. It is unsecured debt. If they want, borrowers can decide to not pay their loan back (though their credit score will go down).

Instead of trying to avoid defaults completely, investors diversify in enough loans so that a single default does not have much effect. For instance, if we pick up 200 notes and one defaults, we would would only lose 1/200th of our investment – or 0.5%. In fact, if we own enough loans, we begin to mirror the average default rate of the entire Prosper platform – and this default rate is quite consistent year by year. Basically, if we diversify in enough loans, we can bake the default rate into our overall strategy, and not care too much when one finally occurs.

There are some rare things that could increase the default rate beyond our control. The first is national economic factors, like the U.S. unemployment rate. If this rate climbed extremely high to something like 20%, even borrowers with good credit might lose their jobs on a large enough scale that our investment could be affected.

The second scenario is if Prosper lowered their underwriting standards. Currently, they require a minimum credit score of 640 for a borrower, so if they lowered it to something like 500, our investment would be impacted. That said, Prosper’s loan standards are being monitored by many independent observers, so they could not loosen their underwriting without suffering negative publicity.

#2: Interest rates rising (unlikely)

If national interest rates rise, peer to peer lending would definitely change. For instance, in the 1980s the interest rate at a bank was close to 5%. Why would an investor try to earn 5% in peer to peer lending when they could earn 5% in a risk-free savings account?

Peer to peer lending would certainly adjust to rising interest rates, but probably not to a huge degree. The safest A-grade loans that return 5% might struggle for funding, but the rest of peer to peer lending that returns a realistic 6-10% per year would remain the great investment that it is today.

#3: Prosper might go bankrupt (very unlikely)

Although rare, it is possible a peer to peer lender could go bankrupt. Companies like Prosper have not even been in business for 10 years, and something newer is always less predictable than something more aged. To lessen these concerns, Prosper has done a great deal to help investors in the rare instance that their company would shut its doors.

The first provision is the backup servicer for their loans. If Prosper would shut down, they have prepared a backup service that would make sure loans payments from the borrowers would still flow to the investors. The second provision is their bankruptcy vehicle (see picture on the right). In the event of a bankruptcy, the portion of Prosper’s company that holds these loans would split off from the rest of the company. While creditors could liquidate the company’s other assets to pay off debt, the actual loans would hypothetically remain untouched.

These bankruptcy protections are quite remarkable. I don’t know another company that has gone to such lengths. However, the bankruptcy of a peer to peer lender has never happened before, so we can’t be completely sure these provisions 100% work. As such, it is wise for people to have only a portion of their overall investment at Prosper – perhaps with other portions split into more traditional investments like stocks, bonds, and CDs.

Finally, it is worth mentioning that Prosper is becoming more trustworthy and successful as a company each year. Just last year we had BlackRock, the world’s largest asset manager, partake in a $25 million fundraising round for Prosper. To boot, the company has experienced 434% growth in the past twelve months. A bankruptcy event, it seems, gets rarer each year.

#4: Something unpredictable

Prosper launched in 2006. Even though it continues to grow by leaps and bounds each year, it is still not as predictable as investments that have had 100+ years of history backing them up. As a result, there are many unknowns involved with this investment; each year Prosper confronts new and interesting challenges. It is wise to stay up to date on this company by frequenting investor websites like LendingMemo, perhaps subscribing to our newsletter (see box on the right).

Important: Diversify Your Account

The biggest reason new investors experience negative or poor returns at Prosper is their lack of diversifying in enough loans. As I mentioned in the Risk section, the diversification point is met when we invest in 200 equal notes. Further, since the smallest note size at Prosper is $25, this means most investors need $5,000 to get started ($25 times 200 = $5K). It is possible to invest using larger notes as long as the entire investment is spread across 200 of them. IE: investors with $10,000 could start with two hundred $50 notes; investors with $100,000 could start with $500 notes, etc.

Exception: you may begin investing with as little as $2,000 (just 80 notes) as long as you stay in the safest AA-grades. The data seems to indicate that these lower-risk loans have a lower point of diversification (read this). Prosper may not have 80 AA-grade loans available at once, so you may have to log into the website a few times to get fully invested. If you want to take on risk in additional loan grades (like C-grade loans), you must increase your investment to $5,000.

Step-by-Step Investing at Prosper

Alright. Now that we’ve highlighted the benefits and risks of becoming a Prosper investor, let’s look at the actual website and see peer to peer lending first hand. There are many areas of Prosper’s site that are worth exploring, but here are the biggest five:

#1: The Home Account Page

Above you can see the home screen of my Prosper account. This is the main account page for investors, with all the main pieces of information we need to see how our account is doing. The big two numbers are (1) the account’s value, and (2) the account’s annual return. Beneath these are some secondary figures, such as how much available cash is in my account.

One thing to notice here is Prosper’s Seasoned Only return vs All Notes return. Basically, peer to peer loans that are at least 10 months old are a far better indicator of an account’s return (most defaults happen early on), so Prosper helpfully gives us an annual return based on seasoned notes alone.

#2: The More Details Page

If you’re new to peer to peer lending, this page might seem a bit overwhelming. Don’t worry. While helpful, much of this information is not super crucial to being an investor at Prosper. Personally, I like looking at the top-right and seeing the lateness of all my notes. For example, my account currently has 367 active notes. 21 of these are late. Below these, you can see that 75 of my notes have defaulted (charged-off), and 127 were paid off early.

#3: The Browse Listings Page

By visiting the Browse Listings link, you will arrive at a screen that shows the loans available for investment at Prosper. When issued, each loan represents a borrower with good credit who has passed Prosper’s underwriting standards.

Prosper Loan Grades: The main item investors examine is a loan’s rating (grade). Looking above, you can see some loans have been given an AA-rating, others a B-rating, and another a D-rating. Prosper gives every loan one of seven loan ratings: AA (lowest risk), A, B, C, D, E, and HR (high risk). While every borrower is prime-rated, some are riskier than others, and the way we allocate our investment into different ratings/grades will have a strong impact on our investment’s overall return. I personally invest in lower-grade loans (C-HR) because I am younger and can take on that risk. This has given me a return of over 10%. However, most will probably want to spread their investments across multiple grades so as to have a more balanced approach. Others may want as little risk as possible, sticking with just AA-grade loans. Every investor’s needs will be different.

#4: The Quick-Invest Tool

Prosper’s Quick Invest is what we use to invest a lump sum quickly and easily. The tool is quite simple. You just select your preferred note size ($25 for most) and rating (risk grade) and click the Find Loans button at the bottom of the screen. One button on the next page, and you have invested your lump sum.

The red arrow in the picture points to Prosper’s Automated investment tool. You can set Quick Invest to automatically find and invest in notes for you, making peer to peer lending a near hands-off experience. Personally speaking, I have found automatic investing at Prosper a really great option. It makes peer to peer lending not only a great investment, but also one I rarely interact with on a week to week basis.

A word on cash-drag: The biggest benefit to auto-investing is reducing the balance of your uninvested cash. These funds are just sitting there, earning no interest. Over time, uninvested cash will bring down your overall return. If you choose to skip automatic investing and do it manually, you will need to set up a routine where you log in and put available cash to work.

#5: The Notes Page

Click to enlarge

The notes page is where you can pull up a list of your Prosper investments. You can see each loan’s status here, meaning whether a note is current or late on its payments. You can also sort these notes by loan grade or date, giving you a good feel for how your investment is doing overall. If you’re interested in a specific note, you can click on its ID for a closer look at its repayment history.

Taxes at Prosper (Hint: Get a Retirement Account)

One of the few things investors discover later on that they wish they had known earlier is about paying taxes on Prosper earnings. In short, it can be a chore. Since peer to peer lending is a brand new way to invest, it does not have a special rate like capital gains. You will likely pay the same tax rate here as you pay on your savings account interest. For many, this means 30% of your Prosper earnings are lost to taxation.

To combat this, it is helpful to invest through a retirement account, and Prosper allows IRAs and 401(k) rollovers. However, most investors only go with a retirement account once they have become comfortable with this investment via a regular taxable account. That said, I have invested in a peer to peer Roth IRA, and look forward to withdrawing my investment tax-free when I turn 60.

Conclusion: A Consistent, Rewarding Way to Invest

I have been investing at Prosper for years. Lots has changed in that time, but I can honestly say that the investment has been great. My borrowers continue to reveal themselves as trustworthy prime-rated candidates of my extra cash. What has perhaps been the most surprising of all is how uneventful this investment is. Once an account seasons, almost every quarter is the same.

For instance, this past summer I actually forgot to check my Prosper investments for over two months. When I finally logged into my account later on, I discovered that (again) nothing had changed. Borrowers had paid off debt; I had earned a great return.

Begin investing at Prosper:
Click to open an account (free).

[image credit: Bob Doran "wildchick17.JPG"
Steven Depolo "Money Hand" CC-BY 2.0]

The post Prosper Investor Review: Earn 5-10% in Peer to Peer Lending appeared first on LendingMemo.

Every new investor has to answer the question, “What loan grades do I invest in?” This is really important to ask because its answer has a weighty effect upon our overall experience. Those who choose safer grades will have a safer investment that may yield a lower than average return. Those who choose riskier grades may have a more volatile investment that yields a higher than average return.

So which grades are best? The answer: it depends on where you are in life, and everybody is different. Every investor’s circumstances will push him or her toward the best choice of loan grades for their specific situation.

Today we will explore the relationship of loan grades and risk tolerance in peer to peer lending. My goal is that, by the end of this article, you will be able to confidently identify your particular risk tolerance for investing at Lending Club or Prosper.

Risk/Reward as Universal Truth

The concept of investor risk tolerance is fairly straightforward. Every investment in the world has a tradeoff between risk and return, with ‘risk’ meaning the wildness (volatility) of the investment and ‘return’ meaning the potential the investment has to make you money (yield).

For example, the more risk you take on, the higher the chance you have to earn a great return. However, you also increase your chances of having a poor or negative experience as well.

Here is a helpful chart that explains this relationship. Where you fall on the gradient above is your risk tolerance, or, your ability to tolerate a more volatile investment.

Some people have a lower risk tolerance. They are at a place in life where they really have to protect their savings, and losing money might be a major setback. Other people (like myself) are in a place in life where they are able to take on more risk. They have a greater risk tolerance. If they lost money on their investment, it would certainly be a bit of bad news, but they would remain good overall.

Loan Grades at Lending Club & Prosper

Using complex statistics, Lending Club and Prosper assign a grade to every loan on their platform. This grade is related to the interest rate each borrower will have to pay on their loan. For example, borrowers assigned a 7% interest rate on a loan typically have great credit history, and are more likely to pay their loan back than other borrowers. Thus, they are given an A-grade.

In peer to peer lending, our individual risk tolerance is related to the grade of the loans we invest in.

Both platforms have seven risk-grades they give their loans. Lending Club’s grades span from A to G, with A-grade being the safest. Prosper starts with the safe AA-grade, then grades A through E, and finally HR (high risk). In peer to peer lending, our individual risk tolerance is related to the grade of the loans we invest in.

Let’s take the risk/return chart from above and insert these seven loan grades:

As previously stated, these grades indicate risk, like how A-graded loans are issued to safer borrowers who are more likely to pay them back. But a loan’s grade also communicates to investors the potential return for each loan. A-graded loans only have a 6-8% interest rate, so they may earn investors a 5% return after defaults. In this way, peer to peer loan grades communicate both a loan’s risk as well as its potential return.

Every loan at Lending Club and Prosper is prime-rated (but some are more prime than others)

It’s worth stating that every loan on these platforms has passed underwriting standards, and is therefore a decent investment. That said, the grades we choose greatly impact our return.

For example, I personally invest in D-G graded loans at Lending Club, and feel this approach has been the main reason my return has been higher than most investors I come across. But my returns are also more volatile than many investors, meaning my ROI goes up and down more regularly. This volatility also means investors who open a high-risk account at Lending Club or Prosper should probably start with a minimum of 300 notes (read: The Relationship of Risk and Diversification).

Other investors earn a lower return than me because they invest in the safer A-C grades, and this lower return does not mean they have a worse investment. Studies have shown my D-G graded loans yielding poorly in scenarios like a drop in the national economy. But safe A-graded loans to borrowers with excellent credit fare much better. Further, the stability of A-grade loans means they may have a lower point of diversification than the rest, so beginning investors might only need 80 A-grade loans to be fully diversified (AA-grade at Prosper).

See the presence of risk and return in peer to peer lending? Safer loans from trustworthy borrowers are less likely to default, are more consistent, and are more likely to survive a slowdown in the American economy. But they typically only earn investors 5-7% per year. Riskier peer to peer loans are more likely to default, particularly in a bad economy, but have historically earned investors an 8-10% return or more.

Four Types of Risk Tolerance at Lending Club & Prosper

To nuance this idea of risk tolerance, I’ve created four investor personas, each with a different peer to peer lending risk tolerance. Note: the loan grades these people choose are generalizations. Your particular allocation will likely be different.

“Duncan” from Delaware: Should not invest

Duncan and his girlfriend are expecting a baby in six months. Actually, they just got engaged to be married, and Duncan paid for the ring with his Mastercard. Added to the student loans he has yet to pay back (at a 7% interest rate), Duncan is $34,000 in debt with no savings. He has been chipping away at this debt each month, but it’s tough work. He just heard about investing at Prosper and is intrigued.

Duncan should not begin peer to peer lending. First, he needs to get his financial and social situation stable, pay off his debts, and establish an emergency fund.

“Mitch” from Maine: A lower-risk investor

Mitch is a retired architect who used to build corporate offices. He is 78 years old. Through savvy budgeting and decades of employer matching-contributions, Mitch has built up a sufficient retirement fund for himself and his wife. He enjoys spending time with his grandchildren, fishing, and smoking a good cigar, but still has to be careful with his cash if he wants it to last through his golden years. He just read about Lending Club in the news, and is considering opening an account.

Because of his age and situation, Mitch has a low risk tolerance. If he would lose a portion or his entire invested cash, he has almost no ability to go back to work to make more. As a result, Mitch might want to safely allocate his Lending Club investment in As and Bs.

“Rita” from Rhode Island: A medium-risk investor

Rita’s appraisal business has grown since its inception in 2009. At age 36 with two young boys, she stays quite busy each week. However, she and her husband have no debt at all besides the mortgage, and together earn over $240,000 per year. They are saving to send their kids to college, and have plenty of bills, but situation allows them to invest $15,000 of their savings into Prosper, which was mentioned on their favorite radio talkshow last month.

Rita might be an example of an investor with a more medium-degree of risk tolerance. While she and her husband have a lot of responsibility to manage, their healthy salary and relatively young age allow them to allocate a Prosper investment more broadly across many grades.

“Neville” from Nevada: A higher-risk investor

If you ever go to Las Vegas and rent one of those outrageous Hummer limousines, you might catch a glimpse of Neville in the back of the store. Five years ago, his computer programming talent got noticed by the largest rental service in town, and now Neville manages hundreds of vehicles, programming the various touchscreens inside these party limos to play games, music, and spout interesting facts about the city. Neville is 28 with no kids or debt, and earns an annual salary of $82,000. He just heard about Lending Club through a friend.

Because of his young age, respectable income, and few expenses, Neville’s risk tolerance is higher than most investors. If he put $7,500 to work at Lending Club that earned a negative ROI, it would not be a huge setback. As a result, he can afford to be less cautious and shoot for a higher return. His Lending Club account might be set up like this:

Most Investors Take on More Risk Over Time

If you are brand new to peer to peer lending, it is understandable that you are hesitant to take on very much risk at all. Opening your account and funding it with the $5,000 minimum may feel risky enough. As a result, you may start in the safer A and B-grade loans.

That said, most (diversified) investors have a great experience at Lending Club or Prosper, and eventually change their strategy to include riskier graded loans that are likely to give more return. In his Reader Story, Jack from Illinois summed up his change in risk tolerance quite nicely:

“I am happy with my returns since I changed my risk tolerance from ultra-conservative to somewhat aggressive. When we were coming off of the 2008 financial crisis, I only invested in A and B-grade loans. After a year, I switched my strategy to C-grade loans and below, since it seemed people were getting better returns in these riskier loans without a large increase in defaults. On Lending Club I went from an 8% to almost a 10% return in the past 18 months by switching to this strategy.” Read: Jack’s interview

The ability to self-select your risk remains one of the best parts of peer to peer lending, because it means we can tailor our investment’s potential to our particular situation. Investors with higher risk tolerance like myself are more than happy to stomach a 8% loss to defaults if it means earning a net 9% per year. Concurrently, investors with less risk tolerance are just as happy to earn a still-respectible 5% on safer loans that have a great default rate of just 1.6% (see NSR).

Questions/comments? How does your life situation affect the grades you choose?

[image credit: Pink Sherbet Photography "Free Child Walking"
Kevin D "Untitled"
torbakhopper "The Old Man and the Sea"
Steve Wilson "Business woman"
Rob Boudon "Matt Siffert" CC-BY 2.0]

The post Risk Tolerance 101: Loan Grades at Lending Club & Prosper appeared first on LendingMemo.