Peer to peer lending

[zen]

I'm interested to hear your opinions about peer to peer lending. For those who don't know the concept, these sites basically directly connects people with some leftover cash to people who want to borrow it, cutting out the bank that would traditionally sit in between them. Some examples are http://www.lendingclub.com in the US, and www.isepankur.ee in Europe (there are many others).

From what I've been able to find, people generally report quite good returns from these sites, for example MMM http://www.mrmoneymustache.com/2013/08/ ... s-crowded/ reports an annualized return of 17% (although decreasing). How risky do you think these loans are during different economic circumstances?

[flyingpylon]

I would like to try P2P lending with a little "play money" but sadly, it is not available in my state (Indiana).  I'm not sure why.

[Libertarian666]

My theory is that if a bank won't lend to someone, there's probably a good reason.

[Austen Heller]

I have some experience with P-to-P lending, I have been using Lending Club for a few years.  I started in 2009, and invested in a total of 140 loans (all were $25 or $50 each).  In the end, 14 loans out of the 140 were "charged off" (meaning that 10% of the people stopped paying me and I lost most of my investment).  Almost all of the rest of the loans were paid off early or paid off on schedule (I only use 3-year loans).

In the end, my total annualized return was about 6%.  Not bad, but not worth the hassle.  I have family members who I convinced to try it, and they just about broke even.  When you are only investing in a small number of loans like I did, then luck will play a large role in how much money you will make.  For me, there are too many risks too justify investment in a larger number of loans.  There is the risk of default by the borrowers (which in my case was only about 10%), but there is also the risk that the Lending Club company itself will go out of business.

If you're looking for entertainment, I say go for it.  It's fun to read the borrower's stories about why they need the money (some were quite ridiculous, like borrowing money for a trip to Europe, or for emergency surgery for a friend, but most were just for plain-old debt consolidation).  You also get to see all their stats, such as credit scores, employment and wage history, # of defaults, etc.

I still have my account open, since I have 2 deadbeats that have modified their loans and are now only making interest payments, so it looks like I'll still have those loans for many years to come.  Maybe one day I'll get back into it, just for fun.

[joe]

Amusingly, I posted a very detailed reply to that blog post.  Sadly, it wasn't an accepted comment.  Perhaps because it was too critical?

The main problem with lending club (and it continues to get worse) is liquidity.  When you have $1000 (or whatever) that you want to move into a savings account, a cd, or invest in a mutual fund it takes a few seconds and you are done.  You immediately start earning interest, getting dividends, CAGR, DRIP, etc.  This is wildly different than what happens at lending club.  To illustrate here is a glimpse at an additional investment I made at the start of august...

1)  Set up money transfer...wait 4-8 days
2)  Money is "available" so log in at next release
3)  Click filter and pray for 2-8 notes
4)  Instantly try to invest in all available notes...at least 1-3 will be "closing" as they are snapped up in literally seconds
5)  Repeat step 2-4 at all releasees (6am, 10am, 2pm, 6pm PST)

This might sound tolerable to some, frustrating to others, but this isn't all.  Once you finally place your orders you now wait, and wait, and wait and hope that your money actually gets invested.  More and more I get emails like this:

Your investment order xxxxxxxx submitted on August 8, 2013 has been processed. Of the 1 note(s) in your order,
for a total of $xxx:
1 note(s) did not issue

That is an email from today.  That means for the last 3 weeks my money has been sitting there not earning anything.  Now I get to repeat steps 2-5 again and hope that this time the notes will actually process.  Sometimes they do in a couple of weeks and sometimes the process repeats further.  If you buy a 60 month note and it takes 2 weeks,  then this doesn't impact your total return rate very much.  In some cases it can take months to get a 36 month issued and then...

There is a certain percentage that is paid off early(a surprising number to me in the first month or two, likely as lending club has people refinance to 'better' loans).  In that blog post I believe MMM is running at a 3% rate or so.  This makes matters worse because you could spend a month or more getting no interest, then once the note finally issues, see it paid off right away.

The problem with all of this is that the shiny "17%" number lending club shows on the account screen appears to only factors in the amount actually invested.  If you transfer $1000 to lending club, have $100 in notes after 2 months, get 10% interest for one month, they will tell you are making 10%, even if $900 is still sitting in cash/waiting to process and even though you've spent months waiting for that first payment.  This causes problems with making direct comparisons to mutual funds or savings accounts where the money immediately starts "working" and the driping/compounding is seamless.

To combat the frustration I tried a few things:

-  I increased the amount per note I invested (I was comfortable with my diversification, please don't throw everything into three notes and consider it a fix lol)
-  I lowered my filtering criteria  (this lowered my expected returns, but so does having money sitting there doing nothing!)
-  I rescheduled my days (I hit at least 3 of the 4 releases every single day for over two weeks)

The result?  The other day I transferred half of the august investment back out.  The other half continues to sit in cash/under review.  Despite my best attempts I am simply at a point where I am finding it difficult to even re-invest my current payments.  I've decided that for now I will hold the value of the account steady and see where things go.  I've heard talks of automatic investment, additional loan volume, etc.  Perhaps this is a hiccup, but right now I expect the situation to get worse and not better.

Of course, that's just to get your money moving, there are two other big things to consider: taxation and default rate.  There's no "unrealized cap gains" or "favorable dividend rate" here, so that "17%" number is further skewed if not sitting in an IRA.  As far as defaults, I can't give you a date, but I can tell you that the projected default rate shown by lending club when investing in notes went up significantly in the last few months.  I don't know if they reanalyzed data, or if maybe they just loosened their standards to try to increase liquidity.  It was kind of jarring the first time I saw notes that previously projected to double digits coming in at single digits.

This isn't intended as a big whine, but I hope it brings to light some things that I don't see mentioned on a lot of blogs with sponsored links telling you how amazing it is getting "17%".

If someone is interested in using lending club they should probably transfer some money and start.  If you "save up" money and try to invest it like you would with a mutual fund then you will just back yourself up more.  You will likely have much more success transferring money every week than you will saving up $3000 like you would for a mutual fund and then "investing" it all at once.

Finally, it's OK to not invest as well.  Some of the posts I've read on p2p lending almost make it sounds foolish to not be invested.  To be honest, I continue to grow uncomfortable with my investment and could easily see myself winding it down entirely instead of holding it steady.  That too will be far more difficult than swapping IVV for VTI though, so please know what you are getting into.

[Austen Heller]

Great post, joe.  A really descriptive post of the current Lending Club investing environment.  Sounds like things have changed a lot since I did most of my loan funding back in 2009-2010.  I guess the years of low interest rates in bonds and CDs have made the p2p sites way too popular.  I believe that humans are still used to weed through all the loan applicants, so at the end of the day, there is just not enough new loans coming on-line to satisfy the big demand for those "10%+" rates.  It's too bad, it was a fun way to invest a few years ago.

[craigr]

If we get another serious hit to the economy, I predict massive defaults in peer to peer land.

You are loaning money to people that are likely on the hairy edge of financial solvency or have other significant bad outlooks on how to use money. The slightest hiccup will send it all toppling over.

[sophie]

If we get another serious hit to the economy, I predict massive defaults in peer to peer land.

Lending Club and Prosper both survived 2008-2009 reasonably unscathed.  Yes, defaults did increase by about 1/4 or so (forget #s exactly), but it wasn't massive.

There will be a role for P2P lending as long as banks continue to charge those crazy 25%+ interest rates for unsecured loans (credit cards).  It is definitely a risky endeavor though.  People should not compare a Lending Club investment to a savings account.  It's strictly VP kind of stuff.

[Pointedstick]

I wonder if massively indebted college students are going to start using these p2p lending sites to pay down their student loans and then default on the now-defaultable loan.

Then again, any who might think of this probably wouldn't become unsustainably indebted to begin with.

[sophie]

I wonder if massively indebted college students are going to start using these p2p lending sites to pay down their student loans and then default on the now-defaultable loan.

I thought of this too.  However, the amount you can get away with is limited to $35K (though maybe you could apply to multiple P2P lenders at the same time), and I'm not sure how likely it is that a newly graduated student will be able to meet the strict credit score & other qualifications.

It would probably be just as easy to go out and get handfuls of credit cards, get cash advances from each, and then declare bankruptcy after paying down student loans.  Even better, do this on top of taking out a personal loan.  There's also checking account overdrafts to play with.  With the insane levels of student loan debt out there, it's amazing to me that this isn't being done routinely.