Is Lending Club A Good Investment For You in 2021?
Peer-to-peer lending (P2P) is a type of debt financing that has risen in popularity over the years. P2P platforms utilize technology and big data that allows people to borrow and lend money from another, without using a traditional financial institution such as a bank. When it comes to P2P lending platforms today, Lending Club is one of the premier names. With the financial market being in a constant state of flux, you might wonder, is Lending Club a good investment for 2021. Keep in mind, we are not talking about buying Lending Club stock, we are talking about lending on the platform itself, especially in the existing low rate environment. There is a search for yield in 2020 as the 10-year bond yield is less than 7%. If you were wondering about Lending Club and its pros and cons, you have come to the right place. We are going to cover all of that and more. Let’s get started.
Lending Club: All You Need to Know
What is Lending Club?
Lending Club is a publicly traded company (NYSE: LC) that is heavily regulated by the Securities & Exchange Commission. The platform provides different types of investment and retirement accounts to qualified investors for as little as $1,000. Historically, Lending Club has averaged returns of 3-85 per year with over 99% of the portfolios (at least 100 notes) witnessing positive returns.
When was Lending Club established?
Lending Club was established in San Francisco in 2007. The firm has facilitated a staggering $35 billion in loans so far. Like any other company, Lending Club has also witnessed ups and downs in its fortunes but has managed to make it through the global financial crisis as well. Over the years, it has built a large gap between its nearest rival Prosper, which is still struggling after a failed attempt to go public in 2005.
How does Lending Club’s P2P process work?
The company screens potential borrowers and services the loans, assigning a grade to every approved borrower using credit and income data. The final decision to lend money lies in the hands of the investors.
In other words, the loan grade determines what range of interest rates borrowers qualify for and helps investors decide whether or not to fund each loan. Only investors have access to the borrowers’ grades.
What is the minimum FICO score for Lending Club?
Borrowers who want to be approved for a Lending Club loan must have a minimum FICO score of 660. Lending Club rejects more than 66% of its loan applications so if you are a potential investor, you can feel safer knowing that your money won’t end up as a non performing asset in the future.
Upon approval, the borrower is graded. This process helps determine the interest rates. Keep in mind, approval doesn’t mean that the borrower is default free. Borrowers with lower grades have a higher risk of default and can default, which is why a higher rate of return is required.
Loans for individual borrowers range from $1,000 up to a maximum of $40,000. Rates are competitive when compared to traditional banks and start as low as 5.31% APR. Each borrower’s interest rate is set for the entire duration of the loan, this can vary between three to five years. The loans are unsecured lines of credit (similar to credit card loans). Similar to credit cards, defaults are reported to the credit rating agencies like Equifax, TransUnion and Experian.
The platform offers individual loans, small business loans, auto refinances, medical expense loans and more. Investors have the option to lend to the borrowers with notes starting with a $25 per note minimum.
Lending Club: Pros and Cons
To arrive at any kind of conclusion about Lending Club, it’s very important to analyse its pros and cons thoroughly. Here they are:
Lending Club: Pros
- Diversification: The age old adage of investing is to not have all of your money pooled into one kind of investment tool. Lending Club is a good way to diversify your investments.
- Wide selection: With Lending Club, you can easily filter and choose investments on the basis of categories such as loan type, credit score, purpose of loan, etc.
- Automated Investing: If you don’t have the time or know-how, let Lending Club do the investing for you based on your own parameters.
Lending Club: Cons
- Lack of liquidity: If you want to take your money out, you have to wait until each loan comes due.
- Taxed At Ordinary Income: This can be a major problem for investors who have a high income.
- 1% Annual Fee: Lending Club charges 1% annually per note you own within the marketplace.
- Unsecured Debt: Unlike an auto or home loan, this debt is unsecured. Lending Club doesn’t have the option to collect its loan against the borrower’s assets in case of a default.
What are the risks associated with Lending Club?
The most glaring risk associated with Lending Club is the fact that the loans are not FDIC guaranteed. It puts it on the same boat as stock investments and real estate investments. The only investments that are guaranteed are CDs or money market accounts up to $250,000 per account holder.
Here are the main risks to investing in P2P lending.
- Inflation Risk: Just like any other kind of investment, inflation is a big problem with Lending Club as well as it can eat into your returns.
- Fee Risk: Current management fee is 1%, but it could go up or down.
- Marketplace Risk: In case Lending Club suffers from bankruptcy, taking your loans back will take time. However, Lending Club is a publicly traded company with a positive operating profit, so a chance of bankruptcy is quite low.
- Callable Risk: Loans can be paid off early, which isn’t really great if you have a performing loan. It does help with liquidity though.
- Liquidity Risk: Unless the loan is paid back in full, your money is locked up. However, you can sell your loan on the secondary market, albeit at a discount.
- Economic Risk: Another financial crisis can lead to a sharp increase in defaults.
How to invest in Lending Club?
Potential investors should focus on higher quality borrowers in the A and B grade. While the interest payments might be low, the likelihood of the loan being repaid is a lot higher.
Focus on high quality borrowers who are looking to refinance their credit card debt. Credit card debt often runs in the 15% – 30% range, which is why to such borrowers, paying 6% – 10% is a good deal. If possible, look for borrowers with a FICO score of at least 680, a debt-to-income ratio of at least 30%, no delinquency history, and positive reviews.
It’s important to diversify your loans into at LEAST 10 investments if you start out with a small investment. As per Lending Club, if you had a 100 investment portfolio, you would have still made money during the financial crisis vs. -50% in the S&P 500.
What are the tax implications of Lending Club investments?
Just like any form of investment, all of your returns are taxed at your federal and state marginal income tax level. Even if you hold the notes for more than a year, will not avail the benefits of the long term capital gains tax rate. You can try your hand at Lending Club’s self-directed IRA to defer on taxes until exit.
What are Lending Club’s investing requirements?
Lending Club is available to investors across all American states except Alaska, New Mexico, North Carolina, Ohio and Pennsylvania. In most states, you will need to have a gross annual income/net worth of at least $70,000 to be able to use Lending Club. In California, this number rises to $85,000. Truth be told, nobody really checks these things. However, in case you are a California resident and your net worth is more $200,000 ($250,000 everywhere else), the annual income requirement is waived off. In case you are from Kentucky, you must qualify as an “accredited investor” under the Securities Act of 1933. In order to get started, you need a minimum of $1,000.
How to open a Lending Club account?
These are the types of accounts you can open with Lending Club:
- Traditional IRA
- Roth IRA
- Simple IRA
- Rollover IRA
You should start with an investment of at least $5,000 so that you can get as close to 100 investment loans as possible. The most efficient way to open a Lending Club account is via an IRA because of tax deferment. All income generated through Lending CLub is taxed as ordinary income.
Lending Club: Conclusion
Investing in peer-to-peer lending is a good way to add some diversification to your investment portfolio. P2P lending is a good kind of passive income investment.
Since P2P is an alternative kind of investment, try to ensure that your exposure to Lending CLub is no more than 20% of your overall portfolio. Remember, it’s quite tough to get a good yield these days. Even if Lending Club only provides you just a 6% yield on a diversified portfolio, it is still way higher than the 1% that most bonds offer.