No Longer Fat Cats: Why We’re Quitting the Lending Club

fat-cat

I first heard of peer to peer lending from some of the finance podcasts I listen to.  I think it was this episode of Listen Money Matters that first introduced me to the concept.  I got really excited about it.  I’m always looking for new ways to invest and this sounded like a novel way to diversify my family’s portfolio.  A year and a half later, my wife and I are starting to pull our money out.

Now, this little experiment with Lending Club has not been a disaster.  Far from it.  We’re still earning healthy returns from our small investment of about $2500.  But we’ve shifted our stance and no longer think it’s the right investment for us.  I’ll share why in a moment.  First here’s some background info.

For those of you who don’t know

Peer to peer lending is a way for regular Joes like me to lend money to individual borrowers and earn interest as they pay that money back.  Platforms like Lending Club and Prosper and the miracle of the World Wide Web made this possible.

“It’s like we’re the bank,” I said to my wife, way oversimplifying it.  “Finally!  We get to be the Fat Cats! Why not put some of our money in and see how it goes?”

Lending Club (the peer to peer platform we chose) handles underwriting and collections for the loans.  They slice the loans up into $25 “notes” which investors like me buy to help fund them.  Because you only own a small part of each loan you invest in you can spread your risk over many different loans.  As money starts coming in from borrowers paying back their loans, you can take the money and run or reinvest the money back into additional notes

The loans are graded A through G.  Grade A loans are considered much less risky than Grade G.  My wife and I bought little $25 pieces of more than 100 different loans.  Being the high rollers we are, we went for the more risky loans (C through G, heavy on E) because they offered higher returns to investors.  Some Grade G loans carry a more than 30% interest rate!

Investors will never see 30% annualized returns, for a variety of reasons, including loan defaults and Lending Club fees.  But 8-12% is not out of the realm of possibility.

That sounds pretty cool, you’re thinking. I’d take 12% annually on any investment.  

That is a nice return.  But, of course, it isn’t guaranteed.

Nothing’s guaranteed at 12%  This isn’t 1973!  

Okay.  Okay.  Great point!  Here are the other reasons we’re exiting the platform:

Less return… More risk?

Lending Club’s average annual return is actually not 12%.  Sure, it’s possible to get 12%.  But investors are currently averaging more like 5-8%, according to Lending Club’s own statistics.  We’ve currently got an adjusted annual return of 6.8%, once Lending Club factors in likely defaults.

Meanwhile, the stock market has historically returned between 7% if you factor in inflation and 12% if you’re a disciple of Dave Ramsey.

Sure, the stock market is volatile in the short term, but volatility isn’t the same as risk.  Long term, the stock market has been as close to a sure bet as anything, consistently bouncing back from hard times and delivering healthy gains.  That’s no surprise, since the stock market essentially represents the sum total of human productivity and ingenuity.  We’re plucky little beings, it turns out.

It looks like there’s less to gain with Lending Club.  And much more risk.  With peer to peer lending, you are investing in unsecured loans taken out by people, who, in many cases, haven’t been very responsible with their money.

That risk and the fact that the average gains for Lending Club don’t beat even the most vanilla stock market portfolio in the long-term is one reason we’re stepping away.

Fees and taxes

Stock market investing wins here too.  Maybe as the peer-to-peer matures, this will change.  But right now, expect to pay a 1% fee and up to 30% in taxes (depending on your bracket) on your Lending Club gains.

Contrast that with the minuscule 0.05% fee charged to my Vanguard Total Stock Market Index Fund (VTI) and 15% capital gains tax for long-term investing.

That’s a significant difference.  Fees and taxes make Lending Club less appealing.

Lack of true liquidity

You can liquidate your Lending Club position without waiting out the terms of the loans (Loan terms are 36 month or 60 month, by the way.  Most are 60 month).  But selling Lending Club notes is not nearly as easy as selling stocks.

I’ve never sold Lending Club notes on the secondary market.  We plan on cashing out as payments are made and the loans mature.  But, fortunately, Jonathan Ping from My Money Blog does a great job explaining how it works in this post.

One of the things Ping says that stuck with me, is that the notes that have had a previous late payment are really difficult to sell.  Note buyers “seem to avoid [them] like the plague, even if they revert back to current,” he says.  “If you really want to sell those last few loans, you may have to put them up at significant discount of 10% or more.”

The lack of true liquidity here is hard to swallow.

Borrower behavior

I have no doubt that the vast majority of Lending Club borrowers have every intention of repaying their loans.  But shit happens.  And the more I thought about it and put myself in borrowers’ shoes, the more uncomfortable I got about our Lending Club investment.

If I got in severe trouble financially, my Lending Club bill is one of the last bills I’d pay.  For some people it might even come behind cable.  What happens during the next economic recession when borrowers have to make the choice between paying their Lending Club obligation or putting food on the table… or catching Season 7 of Game of Thrones?!

We don’t really know how Lending Club borrowers will act in times of severe stress.  We’ve got a small sample size through The Great Recession.  That’s good enough for a lot of investors, but not for me.  I have no doubt there will be a rash of loan defaults during the next downturn.

What if 50% of your borrowers suddenly default in some sort of severe economic shock?  You can’t just wait out the downturn until those notes recover.  Those notes are gone for good.  And the other notes can’t make up that difference.  However unlikely that scenario is, it still makes me nervous.

Lending Club padded its stats

Finally, this Bloomberg Article and the revelation that Lending Club padded its stats for to impress Wall Street doesn’t help.  It looks like this behavior may have been isolated and it doesn’t look like it negatively affected any of Lending Club’s members.  But I’d be lying if press like that didn’t factor into our decision to pull out of the club.

The bottom line

Lending Club was a fun little experiment with a new kind of investment vehicle, but it isn’t for us.  We haven’t lost money, but we’re winding our account down.  We value liquidity in our taxable accounts.  And if we’re going to take on extra risk with our money, we want the opportunity for much larger gains.

What are your thoughts on Lending Club and peer to peer lending?

Please do your own research before investing.  I am not a financial expert and these are my opinions.  

follow me on Twitter @cabbageblog

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9 comments

  1. Thanks for your review of Lending Club. I’ve been thinking about doing peer-to-peer loan investing (just to try it out), but now I don’t feel like I have to! Thank you! The point about liquidity is particularly pertinent, that would make me a little uncomfortable. I also agree that in times of stress these loans don’t seem that likely to get prioritized. Thanks again for sharing!

    Liked by 1 person

    • Thanks for the comment, Jay! Yep. The liquidity part was pretty hard for me to swallow. I definitely wouldn’t put money in that I would need in a year. It sounds like the secondary market is fairly robust, but it’s definitely not a sure thing notes will sell easily.

      I’m actually interested in looking into equity crowdfunding, which is a fairly new thing to retail investors like me. Don’t know much about it, but it seems like it might be fun to dabble in with “fun money”. I like to imagine it’s a little like Shark Tank, me being the shark.

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  2. I fully agree with the points you are making. Peer to Peer Lending is quite interesting as a concept and for small amounts, but from a risk-reward perspective there are more attractive alternatives (stocks, real estate etc.) for long term wealth building.
    Good read, thanks for sharing!

    Liked by 1 person

    • Precisely! Also, I didn’t really go into this in the article, but I got to thinking… It tries to be a non-correlated asset like a bond, but in many ways it’s more correlated to the stock market than bonds. Stock market does poorly, reflecting poor earnings –> more layoffs –> more defaults. My thoughts anyways. Thanks for reading!

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  3. We are using a P2P lending/crowd-funding platform for personal and business loans. Minimum amount to entire is €100 per project. We have also decided to wind down these investments for similar reasons why you are pulling out.
    Again, also not because of the current yield, which is at an acceptable 7% for now (started out at 8%). But more because there is only downward potential and many business owners actually have no idea how to run a business and most people don’t know how to handle money. Out of 33 “projects”, about 4 have defaulted, been taken over or issues. The impact is currently no too bad, but no idea where it will be doing in the next 3-5 years.

    Liked by 1 person

    • The thing that’s discouraging to me is that this is supposedly the “good times” (at least a period of steady economic growth), and I continue to see our yield go down. Of course, some of that has to do with the amortization schedule of the loans and the fact that we’re not putting more money in, but the pace it’s going down is still faster than I expected. What happens when the economy inevitably turns down again? I just don’t see people prioritizing their P2P loans over, say food.

      And there have been many more defaults than I expected. 20 out of 125 with more to come. I would not be surprised to see our adjusted yield (including charge-offs) turn negative, by the time we have all our money out.

      When we first started with Lending Club, I was a little naive and thought we could somehow “crack the code”, see patterns, choose the people who were likely to continue paying their loans, outperform. In fact, we purposely avoided business loans for the very reason you pointed out (most people have no idea how to run a business). We focused on debt consolidation loans. Now I know it’s impossible to crack the code because individuals are so unpredictable. You have to have a portfolio of thousands of loans it seems to really be assured of consistent performance. And even then you’re looking at something less than the average stock market return. Not worth the risk, in my opinion.

      I’ll be more than happy to get my money back from Lending Club with a little interest at this point (almost halfway there) Not a good place to be for a high-risk investment like this.

      Thanks for reading and thanks for the comment, Cheesy!

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  4. Hey there,

    Based on your comment in this topic: https://crispycabbage.com/2017/07/28/potus-schmotus-market-shrugs-off-trump-troubles-as-i-tuck-and-roll/ I’ve started reading your post over here. The reasons why you quit peer to peer lending and switched to long-term stocks is clear. But you’re only talking about Lending Club here, have you ever tried (or compared) any other peer to peer lending options?

    I’m writing a blog post on my personal peer to peer lending experiences (which will be published on August 9th) – maybe you want to check in later to compare your experiences to mine? Even though I have not much to say on stocks yet, still need more experience with those for a good review.

    Liked by 1 person

    • I haven’t tried any other peer-to-peer lenders. Lending Club is one of the largest (if not, the largest) here in the US. To me, the general concept seems like it would be the same for all. It’s just a matter of how well they vet their loan customers and how good they are at collections when some of the loans default. No matter how good they are at that, though, I think most of my points about the risks of peer-to-peer lending (as I see them) would transfer to other similar platforms. All except the last one about the bad press Lending Club got that spooked me, I suppose.

      That said, I’ll definitely check out your post about your own experience with another platform. See you then!

      Like

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