Some time ago when the entire market was going down I was thinking how else I could boost my savings to create wealth faster than just by saving $100 a month. I was thinking whether to take a second job or not, or how to increase the money I can invest. This is why I came up with my plan to change my ROTH IRA investing strategy (which at that time was actually no strategy at all) into a dividend investing strategy with dividend reinvesting. I wanted to create a snowball so the the reinvested dividends would allow me buying more shares and thus producing more dividends like the snowball falling from the hill and sticking more snow on itself thus growing in diameter.
I was disappointed with the results of my my saving and investing effort and my investments were still too slow in contributions and growth (not accounting loses I suffered). I wanted more free money for investing every month. So I was searching across the internet to find more opportunities to invest my money or make more money and force them work for me and generate more new money for investing. I tried “pay per click” websites, but most of them turned up to be junk which did not pay promised “earnings” and I didn’t want to spend my free time clicking endlessly on ads to receive $0.0001 per click. Moreover I had no time for doing it since I am quite busy during the weekdays and I want to rest over the weekends rather than clicking on boring ads. Same case with second job. Time to time I take a side job of AutoCAD drafting to make more bucks but once again I do not want to spend my precious free time by working.
So I came across Lending Club. A relatively new pier-to-pier lending web site (company) allows its members to either invest money (for investors) to lend them to other members (borrowers). A quite great idea, which on one hand allows borrowers to borrow money on lower interest rate then they could get in banks and investors could earn better interest than you could get in banks, CDs and these days even at the stock market (I am referring to S&P 500 yielding some 3% these days). Of course, there is a risk involved as with any other investing, but it can be mitigated by a proper strategy. It cannot be eliminated at all, but you can lower your exposure to a very minimum. And here I could see an opportunity to create another snowball generating more income.
So, how does it work?
It’s quite easy. I opened an account as an investor and deposited my first $100 dollars (plus I received a referral bonus, which was $25 at that time, but these days you may get up to 100 dollars if you open a new account). Then you can start buying notes, which represent a fraction of loans to borrowers. You can invest as much money as you want into each individual debt note, but the very minimum is $25 per a note. And here comes the strategy you want to use to eliminate risk as much as possible. It is so easy and affordable so everyone can give it a try.
My plan first
Before I continue on describing my strategy, let me state the plan I have with Lending Club. It’s quite simple. I will be investing $100 every month into the debt notes and reinvest all earnings and paid principal back as long as my first year portfolios become 100% reinvested. So for at least next upcoming 3 years I will be investing and reinvesting only and then I will decide what to do next.
My strategy
Diversification limits loses
As I said above, the minimum you can invest into a single debt note is $25. And that is the core of the entire strategy of limiting loses. It is similar to investing into stocks. If you invest all your money into a single stock the risk is tremendous. If you invest into 30 stocks, the risk is lowered. It works same with Lending Club.
I invest 100 dollars every month and purchase 4 debt notes. I have seen some investors use the entire amount to buy just one note and if that particular borrower defaults, they lose the entire money. I never invest more than this minimum and I will never invest into same debt note twice.
In a filter tab I therefore select “Exclude re-listed notes” and “Exclude loans already invested in”.
What’s the purpose of the loan?
I look at the purpose the borrower tends to use the borrowed money. Even though there is no control over whether he or she really used the money as they claimed I decided to invest only in debt consolidation, home improvement or home down-payment loans. These are the loans which will be somewhat backed by a value. First one would release a borrower from a debt, so he or she can pay the loan with a certain ease on their budget, the second could be backed up by a home equity although questionable these days. All other purposes such as car loan, wedding expenses or even vacation expense is totally wasting money and for me it is not a reason for borrowing money. For those purposes I save money so I do not have to borrow, so why others couldn’t do the same?
I am also typically looking how and if the borrower disclose the purpose of the loan. If he or she doesn’t bother with explaining how he wants to use my money, I do not bother investing into his loan. I also check what grammar the borrower use when writing and responding to lenders’ questions. If it is a poor grammar or answers as “yes” or “no” only or half answered questions, I do not invest. I might be a bit lenient on grammar to a certain level, since I myself was originally born in a foreign country and English is my second language, however I am trying as hard as possible to understand it and learn it. With all that I could see some people in Lending Club with so poor grammar that even I could recognize it.
In the filter I then select:
- Refinancing Credit Card
- Consolidate Debt
- Home Improvement Projects
- Home Down Payment
(hold ctrl while selecting in a drop menu)
How much money the borrower asks
Here I act as a bank and try to determine whether the borrower is likely to overextend herself or she is a responsible borrower. The minimum loan amount is $5,000, the maximum is $25,000. If a borrower got himself into a trouble of credit card debt higher than 20,000 dollars so he asks for full amount to refinance or pay down his current debt I do not consider such a borrower responsible. If he got himself into such debt, he may do it again by getting this new loan, pay down his old credit cards, but later start using them again and get into a deeper debt. With such a large debt the monthly payments can easily add up to $800 or more and such a borrower will most likely default and stop repaying the debt.
In the filter I select the maximum loan amount not higher than 10,000 dollars.
Credit score
The Lending club is quite strict and does score screening for us. They do not allow to anyone to get the loan whose score is below 660. For me it is quite sufficient, although not guarantee of a trustworthy borrower. I keep the score filter selection on “any”.
Delinquencies last 2 years
If a borrower was delinquent once in last two years, he might do it again. Such a borrower is not a responsible to me and I do not invest. I am looking to zero delinquencies in past two years. And actually I want all of the following criteria look like this:
- Accounts Now Delinquent: 0
- Delinquent Amount: $0.00
- Delinquencies (last 2 yrs): 0
- Months Since Last Delinquency: n/a
- Public Records on File: 0
- Months Since Last Record: n/a
In the filter I also set to exclude loans with public records and if the loan listing doesn’t look like the one above, I do not invest.
Interest rate
I only invest in loans categorized as “A”, “B” and “C”. I think no further explanation needs to be provided here. Other categories bear so high interest that it could be killing to some borrowers. If someone asks for 24,250 dollars @ 19.41% for example, the monthly payment will be as high as $893.95 and that is quite a large amount and I know I myself wouldn’t be able to afford paying such payment, so how others could be able to keep up paying this amount for 36 months? Some may be able to do it, but how many borrowers are financially this strong? If they have almost 900 dollars available every month, why are they borrowing the money at first?. So I do not invest.
Max debt-to-income ratio
When you ask your bank for a loan, they will look at this ratio to determine how likely you would be able to repay the loan. If your debt is 80% of your income, you most likely won’t have enough for living (unless the borrower has some undocumented income). The standard debt-to-income ratio banks were looking at (at least two years ago) was 35% (I think). So I limit this ratio not higher than 20% to consider the borrower not extendeding herself in debt and having enough resources to pay the loan back.
Funding progress
I set the filter to show only the loans already invested by more than 50%. That can be a good sign that other investors already did the due diligent homework and were convinced enough to invest in such loan. I also check what questions they asked and how the borrower responded. If I am satisfied with questions and answers I do invest or I might ask my own questions.
These criteria won’t guarantee that all the selected notes will go well and none will default, but at least may limit the risk to acceptable minimum. I invest 100 dollars every month, create an individual portfolio of notes for every single month (so I have 6 portfolios and I am invested in 25 notes so far) and reinvest all paybacks back to new notes. My portfolio grows quite well and in my weekly picks review I am already showing the progress in Lending Club investing.
Can you help me with Lending Club strategy? I wish to create a filter as you have!