Are you an investor looking for an alternative to CDs (Certificates of Deposit). You like the idea of lending money, and would like a solid return on that investment, but want something more than you're getting at a bank?
LendingClub offers just that - you can invest as little as $25 into a loan, and potentially realize a solid return. You can get anywhere from 3% to 8%, or sometimes more - much better than any interest rate you get on a CD.
While there are downsides and risks involved, I think that LendingClub is a solid investment and way to diversify your portfolio. Especially for those individuals who are looking for something like a CD alternative.
Let's talk about LendingClub, the ins and outs of peer to peer lending in general, and I'll share my story of getting started with LendingClub. Note, LendingClub provided me an account to invest however I want. I'm using that investment to share with you exactly step by step what to do, and how it performs. Stay tuned for the long run to see what happens.
- Peer to Peer lending, which can be a great CD alternative
- $25 minimum investment per note ($1,000 account opening minimum)
- Best suited for higher income investors, looking for strong consistent returns
What Is LendingClub?
LendingClub is an online peer-to-peer lending platform. What this means is that you can lend money directly to a "stranger" and LendingClub handles all the details like a bank normally would.
This allows investors to become bankers and realize a higher return on their investment than they would normally receive at a bank. It also allows borrowers to potentially borrow at better rates than they would get at a traditional bank. Best of all, this all happens online - making the entire process quick and easy.
It's important to note that LendingClub is not available for investors in every state. Each state has different rules about peer to peer lending, and some states just don't allow it. Check out this blog post to see where LendingClub is available.
How Does LendingClub Work For Investors?
If you're ready to invest with LendingClub, you might be wondering how specifically it works and what you need to know. You might be enticed by seeing returns that exceed the best CD rates available today. As of April 2018, LendingClub is showing historical 10 year returns of 4-6% per year. Much better than anything you can get at a bank.
But remember, risk and return is always correlated. The larger the return, the more risk you expose yourself to. And that applies even more to lending money.
Also, there are basic rules to follow before you can invest. Most investors must have an annual income of at least $70,000 per year, or a net worth of at least $250,000. You also cannot invest more than 10% of your net worth.
The minimum to open an account at LendingClub is $1,000 and the minimum you can invest in a note is $25.
LendingClub also offers both a traditional taxable account and an IRA (Individual Retirement Account). There is no fee to maintain an IRA at LendingClub if you maintain at least a $5,000 balance for a minimum for the first year, and then a $10,000 minimum for the following years.
If you invest in an IRA at LendingClub, remember that you must follow the IRA contribution guidelines across all your IRAs - so you can't invest more than the maximum allowable amount even if you have other IRAs.
Choosing Your Investments
Once you have your account setup, you can choose your investments. LendingClub has two ways to invest. You can manually invest in loans, or you can setup automated investing.
Manual Investing: This is where you can browse individual loans, search by specific criteria, and make investments as you choose.
If you choose to invest manually, you'll see a screen like this with loans that match your criteria:
As you can see, it lists a summary of the information about the loan, including the amount, borrower FICO score, the reason for the loan, and how much is left to fund.
If you want more information, you can pull up a detailed screen with even more specific information:
If you don't want to spend so much time scrutinizing your investments and loans, you can go with automated investing (it's what I do).
Automated Investing: This is where you setup an ideal portfolio of loans, and LendingClub does the rest of the work to fund loans that match your criteria. This is my preferred approach because once you set it up, LendingClub does the rest.
You have two main settings that you can choose when you setup automated investing. You can setup a LendingClub recommended portfolio, or you can create a custom portfolio.
Here's the LendingClub recommended mix:
You can also create a custom mix based on your own criteria. Notice how if you change the settings, it will adjust the returns and potential charge offs.
How Do You Get Paid?
Once you invest, how do you get paid on LendingClub? Well, remember, each note that you invest in represents a loan that someone is paying on. Each month, that person will make a payment on their loan, and LendingClub will split up the payment and pay each investor accordingly.
Let's just say that 200 people invested $25 in a $5,000 loan. Let's say (for simplicity) that the monthly payment was $100. The borrower would pay $100, and you would get $0.50 - your 1/200 of the loan payment.
Now, that doesn't sound like a lot, but when you have a bunch of loans, it can add up. Especially when you remember that each monthly payment includes both principal and interest.
Since you're getting principal paid back each month, you could turn around and invest it quicker - much better than keeping your principal tied up in a certificate of deposit.
Biggest Risks And How To Minimize Them
Once again, risk and reward is the biggest consideration when it comes to LendingClub. Some of the potential returns might excite you, but realize that they are riskier.
When it comes to making loans as an investor, the risks are pretty simple: the borrower is late on payments or simply defaults.
LendingClub provides grades that are based on a variety of factors:
- Credit Score
- Credit History
- Debt-To-Income Ratio
- Recent Credit Activity
Each loan is assigned a grade: A-E, with the higher grades being the safest (and having the lowest returns). They used to have an F and G grade, but discontinued those in 2017.
The cool thing about LendingClub is that they always provide a ton of statistics that are helpful in understanding the risks and return potential.
You can see the returns by grade here:
Remember, that the higher the grade has the lowest risk of default as well. So, while the returns are lower, they are "safer".
Now that you understand the risks, and how credit score and the potential for default play a role, how can you mitigate this? Diversification.
Diversification is key to mitigating risk when peer to peer lending. Let's say you have $5,000 to invest. You could put $25 into 200 loans, or you could put $2,500 into 2 loans.
In the first scenario, if any single loan goes default, you're out just $25 (or 0.50%). If you invest a large amount and that loan goes into default, you're out $2,500 (or 50%). That's why I believe that the best approach is to invest $25 in many loans, and allow LendingClub to handle the rest.
It's important to note that LendingClub does charge fees. We talk a lot about fees and how they can negatively impact investment returns. This is true. So you should always know what you're paying.
There are no fees up front to invest with LendingClub. LendingClub makes it's money servicing the loans. It charges a 1% service fee on each loan payment collected.
Also, if you don't meet the IRA minimums as we mentioned before ($5,000 in year 1, $10,000 after), there is a $100 annual fee.
Finally, if there is a loan in collections, you'll pay a collections fee of 18% of the amount collected. If LendingClub gets a lawyer involved, you'll pay 30% of the attorney's fees.
My LendingClub Experience
I've been using LendingClub for a while, but I'm currently running an experiment in partnership with LendingClub where I'm going to document my performance and how I'm using the platform.
Here's a screenshot of my account as of April 2018 - one month into my investment with LendingClub:
As you can see, I started with a $5,000 initial investment. I've already received $217.33 in payments, which include both principal and interest. I've earned $30.11 in interest in one month - equating to an 8.21% adjusted net annualized return.
Compare that to the top CD rates that you're getting today, and I'm earning about 4x more on my LendingClub investment.
I love LendingClub because they keep things simple. I setup an automated portfolio, deposited my money, and LendingClub takes care of the rest.
When it comes to investing in LendingClub, I view LendingClub as a hybrid of a short term bond and/or high yield savings or CDs. LendingClub is riskier than savings and CDs, having about the equivalent risk to short term bonds. If this is an investment type you're looking to have in your portfolio (especially as interest rates are poised to rise), LendingClub makes a lot of sense.
Check out our other short term investing ideas here.
Using LendingClub As A CD Alternative
Certificates of Deposit (or CDs) can be a stable part of an investing portfolio. CDs are typically considered a conservative short term investment, but I personally also love the emotional stability they can provide to a portfolio as well.
The problem with CDs is that, over the last few years, even the highest yielding CDs barely get to 2.5% interest.
If you're looking for higher returns in a risk appropriate manner, I think that LendingClub is a solid CD alternative.
Second, the highest yielding CDs have long holding periods and substantial penalties. The best CD rates are usually for 5 year or 10 year CDs. These CDs also typically have a 1-3 year interest penalty if you take out the principal early.
With LendingClub, you can invest in 36 month loans (and 60 as well, but you can choose), and you get paid back principal and interest reach month that you can re-deploy as you wish.
I think that the chances are strong that you can outperform 2.5% with LendingClub over a shorter period of time.
Check out the current CD rates below, and see how it compares to LendingClub's returns:
There are other alternatives to LendingClub, both in the peer to peer lending space, and as a CD alternative. However, LendingClub is our favorite peer to peer lender because of their consistency over time, as well as the great platform they have developed.
The biggest competitor to LendingClub is Prosper. Prosper is another peer to peer lender that offers similar services to LendingClub. You can check out our Prosper review here.
You can also invest in traditional CDs. The CIT Bank no-penalty CD is one of our favorites. It’s offered only with an 11-month term. You can withdraw your money anytime after 7 days from funding without penalty. You currently earn a good APY that's higher than most savings accounts, but doesn't compete with LendingClub.
Finally, you can always invest in a short term bond fund in your own portfolio at a low cost discount broker. Remember to check out our favorite online brokers and how you can invest for free.
LendingClub can be a great way for investors who are looking at short term bonds or alternatives to CDs to get a higher yield than they would otherwise. While there is risk, there are steps you can take to mitigate some of it.
If you're curious about LendingClub, you can always read our full LendingClub review here.