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Intrigued by social lending
Question: I love listening to Market Place Money and have so many questions, but I've been able to decide on this one. My wife and I have done a really good job of getting an emergency fund set (roughly 4 months worth of expenses), but the 1.09% APR I'm getting on my savings account is killing me!
I recently heard about a Website called 'Lending Club'. In just my cursory review of what they offer I realize that it's not a savings account, but this 1.0% return on my money in my savings account is really starting to get to me. And with the Fed's seemingly endless policy of low interest rates I'm at my whit's end. What to do? Keep the money in the safe low return savings account? Put some of the money into this 'Lending Club'? Buy gold? Go on a vacation and try to singlehandedly pull the country out of the great recession hangover? Ahhh!!! Anyway, love the show. Thanks. Ryan, Bermuda Dunes, CA
Answer: Ah, a vacation sounds nice. Okay, I have to stop staring at the snow outside my window and dreaming of walking along a sandy beach. On to your question!
The frustration over low rates on savings is growing. It isn't easy to set the money aside and then you get paid an interest rate of 0.1% to 1.2%. (Imagine, banks are marketing accounts paying 1.2% as "high-yield"!). Still, the good news is that your money is safe and it will be there when you need it.
I find the rise in peer-to-peer lending fascinating. The peer-to-peer websites bring together in cyberspace individual lenders and individual borrowers. It cuts out the bank and its overhead costs. The business is an intriguing combination of Match.com, Facebook.com, and Ebay.com.
Peer-to-peer lending and borrowing is about money and community. I wrote about peer-to-peer lending in a post earlier in the year. A decent overview of social lending is offered at Mint.com.
The Lending Club is a major peer-to-peer player, along with Prosper.com. The Lending Club opened for business in 2007 and its net annualized return for lenders has been 9.67%. (Net annualized return is a formula where the numerator comes from the interest received from loans, plus any late fees received, minus the 1% service charge the company imposes.) Not bad, huh. It's a lot better than 1%.
Neertheless, I remain a peer-to-peer lender skeptic. Remember, on average Lake Erie never freezes and the stock market has returned about 11% since 1926. Have you looked at your stock portfolio lately? I'm betting the return over the past few years has been a lot less than 11%.
What's more, you can't make almost 10% on your money in a 1% interest rate world without taking on greater risk. There are very few laws in finance, but the trade-off between risk and return is a durable relationship.
My guess is that with time it will become apparent why financial institutions have credit departments (at least when management pays attention to them).
The returns on peer-to-peer loans vary considerably, depending on the length of the loan, its interest rate and, perhaps most importantly, the borrowers credit quality. The loan experience of Lending Club isn't that long, either. Before putting your hard-earned savings at work in a peer-to-peer lender I'd do some research. Check out the lending forums at Wiseclerk. And this site uses a different methodology to calculate Lending Club returns. When I look at the data it reinforces the message that credit quality really matters.
In other words, peer-to-peer lending hasn't eliminated risk. The key investment question is always: "What is the downside? What could go wrong?"
That said, I do think that peer-to-peer lending can be fun for people who want to act as banker. You can limit your downside risk by lending very small amounts--say, $50--to several different borrowers. I'd also stick to borrowers with higher credit ratings. It's an intriguing way of diversifying a portfolio assuming it's your idea of fun. To me, it isn't all that different from picking individual stocks. It's entertainment. The money comes from your entertainment budget. And hopefully you'll make some money along the way.
Peter - the primary problem I see with your comment is that your tenure on LendingClub is only 18 months. Assuming you didn't fund all your loans on the very first day, your portfolio is quite young, considering these are 36 month loans.
Now, granted the returns at LendingClub appear to be MUCH better than what can be found at Prosper.com (and Prosper even tends to overstate their ROI by employing some sleight-of-hand in their calculations). I have been lending at Prosper for several years - and have found that loans will default at ANY point during the 36 month term, including on the very last payment.
I don't quite think you have statistical coverage to dismiss Mr. Farrell's note of caution as it relates to peer-to-peer lending. The people who come to p2p sites, at this point, don't exactly tend to be prime-grade borrowers.
I'd like to think p2p can become successful as an alternative to normal banks, but my experience has made me conclude that the business model, as it is currently playing out, is perhaps not sustainable. Neither company, as illustrated in their respective SEC filings, is doing particularly well - and are subject to some systemic risk factors not always obvious to their investors.
From the peanut gallery: please do not invest your emergency fund in anything, risky and/or illiquid (like Lending Club). There is a way to sell the notes on Lending Club (called the Note Trading Platform) to get your cash back within a week or two depending upon how long it takes to sell them. But if you have an emergency where you need the money fast, you will be selling your notes at a loss.
That being said, I'm a big supporter of Lending Club and have been a lender since 2007. It's kinda fun buying notes to help people reduce their rates and their debts. I really enjoy those that pay their loans off early, even though it hurts my return. Makes me feel like overall we're doing something to help people out. I only lend my "fun money", though, and never anything that I'll miss if I lose it.
Chris, Great article. Although I have to disagree with your conclusion. I have been an investor with Lending Club for 18 months now and am getting over 10% on my investment. As you say, this is now without risk, I have had several defaults but I still maintain a 10% return AFTER defaults. The secret is diversification - I have invested in over 1,200 loans but I try to keep it to $25 or $50 per loan.
I have written an in depth analysis on the P2P lending industry on my blog. I hope you don't mind me mentioning it here: <a href="http://www.sociallending.net/state-of-the-industry/state-of-p2p-lending-... of P2P Lending in the USA</a>
The bottom line is you shouldn't put all your emergency fund in p2p lending. It is somewhat illiquid because you are investing in 3 or 5 year notes typically. But if I was Ryan, I would take a good chunk (maybe 25-50%) of those emergency savings and put it into Lending Club or Prosper.
