Invest in Peer-to-Peer Lending with Lending Club, Returns and Risks

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I have been lending in peer-to-peer lending networks like Lending Club and Prosper for about ten years now. Today, I want to share with you some of the things I have learned, and you can decide if this is the right investment for you. For those looking for quick answers: yes, peer-to-peer lending is a legitimate investment, the risk level is about the same as high-yield bonds, and the returns level is about 4-7% per year.

How Peer-to-Peer Lending Works

In case you’re not familiar with peer-to-peer lending, these networks bring together a large number of lenders and borrowers.  As an investor, you are the lender and have the option of lending as little as $25 to a borrower.  If you have a large sum of money to invest, you can invest $25 in many loans (recommended), or invest more money in a few loans (not recommended).  As a borrower, you can borrow as much as $40,000, and this amount can come from one lender (unlikely) or multiple lenders.

Here’s a nice image from Lending Club’s How Social Lending Works page.

Invest in Peer-to-Peer Lending with Lending Club, Returns and Risks 2

Lending Club Historical Returns

On their website, Lending Club claims that it provides competitive returns at historical rates of 4% to 7% per year. My historical performance based on investing in 201 notes was at 5.06%, which is right in the range indicated by Lending Club.

Invest in Peer-to-Peer Lending with Lending Club, Returns and Risks 3

As you can see from the chart, your portfolio performance will drop in the first 12 months as dead beat borrowers stop paying their loans. The returns do stabilize across the rest of the holding period.

You can click here to see more Lending Club Statistics.

Peer-to-Peer Lending Risks

Like any other investment, I must warn you that peer-to-peer lending is not risk-free.

Default Risk

When I started, I was enticed by the higher interest rates on higher risk loans (i.e., borrowers have poor credit ratings).  This worked out fine initially, but I ran into more late loans and defaults.

For example, I had two defaults in my Lending Club account that amount to $45.38, which effectively wiped out my gain resulting in a -1.88% loss in 2008. I fared slightly better with Prosper, where I had three late loans, but no default.

Except for one loan, all of these late and default loans are subprime rated loans.  So my advice is:  Stick to prime-rated loans if you want to start investing in peer-to-peer lending networks. Lending to borrowers with excellent credit will not eliminate default risk, but it will significantly reduce that chance of losing your money due to defaults.

Holding Period Risk

Another important thing to realize is peer-to-peer lending is not a liquid investment. Borrowers have 36 to 60 months to pay back their loan, so that is how long you’re expected to hold your investments. In Lending Club, you do have the option of selling your notes sooner through the Trading platform, but you’ll be selling your investments at a discount. This is similar to how you have to pay an early withdrawal penalty when you purchase Certificates of Deposit.

Diversification Risk

One way to minimize your default risk is to invest in many different loans. For loans issued in the past five years (2015-2019), Lending Club default rate is about 1.61% for A-rated loans, 4.42% for B, and 8.29% for D.

This means if I invest in 100 B-rated loans, the chances are 4-5 of them will default, representing 4-5% loss. But if I am only investing 10 loans, there is a good chance that 1 out of the 10 loans will default and my loss would be 10%.

Principal Is Not Guaranteed

Due to the defaults, you can lose some or all of your investment. For example, you deposit $2,500 into your Lending Club account and loan $25 to 100 borrowers. Depending on when the defaults occur, you could lose as much as $1,000 if 40 borrowers don’t repay their loan.

How to Minimize Risks When Investing in Peer-to-Peer Lending

Fortunately, there are ways to minimize the risks involved with peer-to-peer lending. Here are a few things that I look for in my borrowers:

  • Good credit rating – invest in mostly A-rated and B-rated loans, and only a few C-rated loans.
  • Low debt-to-income ratio (DTI) – start by investing in the lowest DTI loans first and move up if you still have more money to invest.
  • Low credit inquiries – this avoid borrowers that try to take out many loans from different lenders
  • No delinquencies – this indicates the borrower is most likely not a deadbeat.
  • Smaller loan amount – this ensures that the borrower is not in deep distress for money.

Additionally, here are a few more tips:

  • Diversify your portfolio by lending only $25 to many borrowers, as opposed to lending a large amount in a few loans.
  • Start small while you’re learning

You should also consider this investment as part of your overall strategy. Personally, I don’t recommend allocating more than 5% of your total asset to peer lending.

How to Start Investing in Peer-to-Peer Lending Networks

To start lending with Lending Club:

  1. Go to Lending Club web site
  2. Click on the Start Investing Today button
  3. Complete the application
  4. Click on the confirm link in the registration email, and login
  5. Click on the Invest button
  6. Complete your profile to verify your identity and link your bank account to Lending Club
  7. Once verified, click on the Add Funds button from the Account tab, and transfer at least $25 to your Lending Club account
  8. From the Summary tab, click on Browse Loans to start lending money by picking individual loans to invest in.

For a first time lender, I suggest using the Automated Investing Tool

  1. From the Summary tab, click on Automated Investing
  2. Click on Start now
  3. Click on All Grades
  4. Click on Save Strategy

The system will begin to invest and reinvest the money for you automatically. You can also use the Build a Portfolio Tool, which is the middle ground between the two options above. You can access this option by clicking Invest >  Manual Investing > Order Builder. Pick the desired filters and then choose between the three options.

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Bottom Line

Like any investment, investing in peer-to-peer lending has its risks. You should evaluate these risks carefully before investing in these platforms. From my personal experience, the risk-reward characteristics feel about the same as investing in high-yield bonds. I experienced about 5% annualized return over the past ten years and feel this is a legitimate investment option for those who want to diversify beyond the Stock Market. That said, I would not invest more than 5% of my total portfolio in peer-t0-peer lending, and I would invest mostly in higher grades loans.

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15 years ago

LOL what a waste of time at these rates, you are giving your money away. You are lending out money to unsecured borrowers at rates reserved for prime and known borrowers. Your local bank would never lend below 9% (best rates) for a personal loan to the most credit worthy borrowers, why are you lending at rates below that?

You’re chasing 3-4% above CD rates and adding so much risk. You’re better off buying high yielding stocks who won’t cut their dividend, a Verizon for example paying 6%.

15 years ago

How much have you deposited into these? I put in 2k and have stopped adding more since I got a few defaults. I never calculated my return. Sounds like you did really well. Maybe I will re-evaluate mine later.

15 years ago

I agree with you that you need to stick to the higher credit grades. I prefer to lend on loans of lower total value. Also, I recommend new lenders learn what the different fields mean to help you evaluate the credit information. Don’t just learn that inquiries means that the person pulled credit to be evaluated for a loan, but that a high number of credit inquiries may mean they person is loading up on debt, other lenders are denying loans to the person, or it might mean desperation for money. Several bloggers gave me some more p2p lending advice… Read more »

15 years ago

My experience with Prosper has not been so positive. I invested about $1800 between 34 loans about a year and a half ago. Of those, 7 have defaulted and 1 is 4 months late (effectively defaulted). I’ve invested mostly in A, AA, and B loans, which net me negative 3.62% Lending Club has been a little bit better. I believe they have higher credit score requirements to begin with. I had $2875 invested in 87 loans. Those are about a year old and only two have defaulted so far, so I think my return is positive there, but have never… Read more »

15 years ago

I’ve done quite well with Prosper. I am hoping to be able to reinvest in them once their SEC filing is done. I have 3 loans, all are current.

15 years ago

I think I am going to add this to my building wealth activity. I think I like lending club better though.

15 years ago

I used Prosper.com for a while in 2007, 2008. It was going well until we entered an unprecedented recession! I’m still at a slight positive at .35% estimated ROI through lendingstats. I guess in hindsight, much better than a 40% wallop in the market. Any thoughts on differences/benefits over Prosper?

15 years ago

I think the recession is about to kill the market. As the recession deepens, the defaults will increase – just like they are with credit cards. Cash out while you can.

The Almost Millionaire
15 years ago

I’ve got friends who are averaging over 10% with P TO P lending, but you are absolutly correct, there is risk and there is fraud out there. Great advice to go in to it with your eyes open.

15 years ago

I have been a Prosper member for over a year now but never really did get into the business of lending money. I signed up with the purpose of becoming a lender to received a better return for my money but just could not pull the trigger just yet. Have heard both positive and negative results but lately have been inclined to really going for it now as there seems to be no place out there where your money can actually make a decent return without any risk involved anyway.

15 years ago

techically isn’t a default on a loan is an investment loss to the lender?
and if so, can this be recovered through tax forms?

15 years ago

I tried to sign up, but I guess you can’t use it if you live in Maryland? Can anyone help me out, cause I really want to sign up to LengingClub

12 years ago

No discussion about peer to peer lending can seem to escape the question of risk and defaults. Now that you’ve been invested in the two networks for over 3 years I would be curious to see how your default rate has changed. Any updates?

Invest in Peer-to-Peer Lending with Lending Club, Returns and Risks

by Pinyo Bhulipongsanon time to read: 4 min
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