Revisiting Passive Income With Lending Club

UPDATE (11/16/2010): Lending Club has ended their “free $25″ promotion, however I still recommend signing up, depositing a little bit of money, and trying it out.  It’s really a nice source of true passive income.

It’s been a long time since I’ve written about Lending Club (aside from reporting my performance metrics in my monthly passive income updates), so I thought it deserved a revisit.  Since I originally wrote my review, Lending Club has made a lot of really nice changes to their website, making it more user friendly and visually appealing.  In addition, they’ve introduced some new types of loans that you can invest in, which I’ll explain further in this article.

The bottom line for me is that this income is pure passive income. Yes, creating a niche website is eventually passive income, but still requires a good amount of upfront work.  Investing with Lending Club is very much a “set it and forget it” type of passive income, where you probably only need to revisit it monthly to check on your performance and invest in additional loans.  Best of all, you can try it risk free (no deposit needed) because they will give you $25 free if you sign up with this link.  Keep reading and I’ll get into the nitty gritty details.

What Is Lending Club and How Does It Work?

Let me refresh you briefly (because I already wrote about this before).  In simple terms, Lending Club revolves around social or “peer-to-peer” lending.  They broker loans like a bank, except that they use funds from people all over the internet.  Let me break down a very simple example for you:

Example

John Doe wants to remodel his kitchen, and estimates the cost will be $10,000.  His credit is very good, but based on what he’s researched, he would have to pay a 10% interest rate on a loan from his bank.  Let’s assume he can’t take out a home equity line of credit.

John decides to check out Lending Club, and notices that with his credit profile (great credit score, no recent delinquencies, low outstanding loan balances currently), he can obtain a loan at an 8.5% interest rate.  This is great!  Over a 3-year period, this should save him at least a couple hundred dollars over what the bank would charge in interest.

Lending Club reviews John’s application, performs a credit check, takes into account his current income and other outstanding debt, and approves John’s loan.  Now, John’s loan appears on Lending Club’s website, and people like you and me can invest in John’s loan.

Wait, I don’t want to invest $10,000 in some stranger’s remodeling project.   You probably don’t either.  This is the great thing about Lending Club.  You can invest in John’s loan for as little as $25.  Because John is a very low risk investment (based on Lending Club’s background and credit check), you’ll earn an 8% interest rate on the investment.  John is paying 8.5%, so that .5% “spread” is what Lending Club keeps as its income on this loan.

After enough people invest in John’s loan and the loan reaches the $10,000 funding mark, the loan becomes active.  John makes monthly payments for 3 years.  He can choose to pay it off sooner if he wishes.  As a Lending Club investor, you receive your share of John’s payments each month, a part which is principal (i.e. the original money you invested) and part interest.

What’s the Risk Involved?

Because you’re going to be earning interest at rates in excess of 7% (the average is between 9-10%), you have to expect more risk than a regular bank savings account (which has virtually no risk, but may only pay 1-2% interest).  In my experience, the risk is relatively low compared to the return you’re receiving.  If you stick to lower interest rate loans (7-8%), you’ll probably find that you never run into someone who doesn’t pay back their loan in full.

One thing I love about Lending Club is that they are extremely transparent with the information that they share.  They aren’t trying to take your money and run – they want you to be fully aware of the risks and they provide plenty of information to back it up.  Here are some actual statistics from Lending Club:

First, here’s a summary of the loans Lending Club has both approved and denied to date, since its inception in 2007:

It’s staggering how many loans requests they’ve denied - approximately 90%.  This goes to show you that before you even see the loans in which you can invest, they’ve done a lot of background work to weed out the potential borrowers who aren’t credit worthy.

You’re probably also wondering – how often do people default on their loans? It’s going to vary to by loan grade (i.e. Lending Club’s rating of risk, which corresponds to the interest rate you’ll receive).  In my experience, I’ve had 2 loans default out of 63, and this is actually worse than what the average person experiences.  For what it’s worth, my two loans that defaulted were two of my lowest grade loans (and were earning me a 12% interest rate).  None of my grade A loans (7.5-9.0% interest rate) have defaulted.

Here’s a chart showing all loans Lending Club members have funded, with the # of defaults for each loan grade.  You’ll need to click the image to enlarge it, but I’ll also recap the default %’s below.

% Of Loans Defaulted (By Grade)

A – 1.05%

B – 3.31%

C – 5.24%

D – 6.36%

E – 9.35%

F – 15.79%

G – 17.72%

As you can see, the risk increases significantly as you move toward the lower grade loans (as you would expect).  If you’re risk averse, you can stick with A grade loans which have an average interest rate of 8.16%, and you will rarely, if ever, deal with defaulted loans (1 out of 100, on average).

The last column in the chart above, net annualized return, takes into account the default rates.  It looks like the best value is actually with E grade loans.  Although the default rate is around 9%, the average interest rate of 16.57% more than makes up for it.  I wouldn’t recommend that everyone invests in these loans, but if you’re willing to take on a bit of risk, you’ll get good value here.

How Does Lending Club Compare to Other Investments?

Rather than do all the research myself, I’ll post an image that Lending Club has up, which compares itself to other investments (over the last 3 years):

Obviously Lending Club is only going to compare itself to investments that it has outperformed, but this is still a pretty compelling argument for Lending Club.

How I Use Lending Club

I consider myself to be fairly risk-averse, so I really like to stick with mostly grade A loans, with a few grade B loans sprinkled in.  Also, I don’t keep a very large % of my portfolio with Lending Club.  I originally started with about $500 in my account, and have since deposited anywhere from $50-100 each month.  As I become more comfortable with it, I find myself investing more.  Generally, I will invest only $25 per loan, to diversify my Lending Club portfolio as much as possible.  If I see a loan I really like, I’ll invest $50.

In case you want to follow along with my fairly conservative “strategy,” here is what my filter looks like for when I’m browsing loans (a.k.a. notes):

The 60-month notes are one of the new additions to Lending Club.  Previously, you could only invest in 3-year (36-month) notes, however now the 5-year notes are available.  Here, your money will be tied up for a couple more years, but you’re compensated with a higher rate (typically 2-3% higher) over that period.  I don’t invest in many of these, but I will select one from time to time if it interests me.

In addition to this filter, you’ll be able to read the descriptions about what each loan is for.  You’ll first see a general subject line, and then you’ll be able to click through to read more detail and see any questions that other lenders have asked the borrower (for which the borrower usually provides answers).  Here’s a snapshot of some of the notes I see with the above filter applied:

[Click to enlarge]

One other thing I forgot to mention – as you receive monthly payments from your loans that you invest in, you’ll eventually accumulate enough money (at least $25) to continue investing in loans.  Each month, I’m able to invest in additional loans without even depositing more money.  The interest + principal that I receive is usually enough to continue investing more and more.

Conclusion and a Free $25

Overall, I think Lending Club is a great place for a small portion of your investing portfolio.  Yes, you’re faced with higher risk compared to CDs and other similar investment vehicles, but you’re compensated with interest rates that exceed most investment types, including the current stock market (broadly speaking).

One great thing about Lending Club is that you don’t need to spend any of your own money to try it out.  They’ll give you $25 just for signing up, but you’ll need to click through my link below (they don’t give any money if you’re not referred by someone).  With this $25, you’ll be able to invest in one note, just to try it out.  If you like it, you can obviously deposit more money.  While you need to fill out a brief application to create an account, you don’t need to provide any credit card or bank information to get the free $25 (in case you’re worried about that).

I highly recommend giving it a try, and you’ll get a sense of what true passive income is really like.  I know it sounds like I’m constantly pushing Lending Club, but that’s only because I’ve used it for almost two years and have had nothing but good experiences.

Click here to sign up to Lending Club and get your free $25 to invest.

If you have any experience with Lending Club or questions for me, please share them in the comments!

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25 Responses to “Revisiting Passive Income With Lending Club”

  1. Hey Eric,

    It all seems really impressive. I just have one little problem: I live in Switzerland. When signing up, I can only choose states from the U.S., do you know if they’re planning to introduce this internationally?

    Cheers
    Patrick

    [Reply]

    Eric G. Reply:

    Hey Patrick, thanks for pointing that out. That’s one important thing I forgot to mention – right now, they only allow US investors. Unfortunately, I don’t know if/when they plan to introduce it internationally, but I can try to find out. I’ll let you know if I hear anything from them.

    [Reply]

    Patrick | Lalala Music Business Plan Reply:

    It’s kind of a bummer! I was really looking forward to trying it out. Do let me know if you hear anything!

    Cheers
    Patrick

    [Reply]

    Eric G. Reply:

    I know, I’m sorry about that. I will definitely let you know if I find something out about it!

  2. Hey all,

    I was completely depressed when I read the above replies – being from Canada, the Lending Club is, clearly, not for me.

    I figured you, Eric, might be a little on the busy side to be able to take time to look for opportunities for other countries – so I thought, what the heck! I will go a-looking!

    Imagine my delight when I typed in Lending Club for Canada and found a blog that discussed not only the Lending Club, but also Zopa (for the UK – I believe one of your other replies mentioned this in another article) AND the possibility of one being opened in Canada! Maybe even as soon as this fall.

    It took me a few seconds of searching the blog to find the site link, but I got it and apparently it is all set up!

    I am still very new to blogging and linking and such so I am just going to type in the link – you may have to copy and paste, but at least we have something.

    http://www.communitylend.com/

    I have not tried it yet (lack of monetary availability), but if someone wants to go ahead I would love to know how it works!

    K

    [Reply]

    Eric G. Reply:

    Hey K,

    Thanks so much for this. People have been asking me about Lending Club equivalents for other countries and I’ve been unable to ever offer suggestions.

    Browsing through CommunityLend for a few minutes, it looks like a very legitimate site, very similar to Lending Club.

    I’ll be sure to mention it next time I discuss Lending Club here.

    Thanks again!

    [Reply]

    Dome Reply:

    I didn’t feel depressed rather annoyed by the impossibility to join at this Lending Club just because not living in the US.
    Considering that I’ve also been banned by Google from the AdSense program for irregular click activity (!) I am really disappointed so far, because I have narrowed choices of passive and semi-passive incomes.
    Sorry if I take it out on you all.

    [Reply]

    Eric G. Reply:

    I wouldn’t feel too annoyed by not being able to join Lending Club simply because you don’t live in the US. Lending Club is a lot like any other financial institution, where they are under certain types of government regulation. It’s understandable why, as much as they would love to offer the site to people outside of the US (it would mean more money for them!), they probably can’t do it legally, or at least, not with the way they have it set up now.

    I’m sorry to hear about Google Adsense, but don’t worry. There are tons of ways to monetize online activity – Adsense isn’t even my biggest! With thousands of affiliate programs, including Amazon (which can be used on many types of sites), you still have lots of options to make money online.

    Best of luck to you!

    [Reply]

  3. Eric,

    I looked at that screenshot…is it just me, but does it say that the LOWEST loan default values were for the (A) (Lowest risk) and the (G) (Highest risk). I think I’m seeing the right thing….does that make sense to you? Any idea why it’s like that?

    From what I can see, it says the (G) has 42 under “default”…and, (A) has 33….so, it appears like the default values of all the remaining loans are much higher…
    Howie recently posted… Why I Disagree with Pat Flynn and Yaro Starak….and, Where Do We Go From Here?

    [Reply]

    Eric G. Reply:

    Hi Howie,

    You may be looking at the data in the wrong way. You’re looking at the total # of loans that have defaulted, but not comparing it to the total # of loans outstanding. So for the (G) loans, there are 42 that have defaulted out of a total of 237, which is a default rate of 42/237 = 17.7%. Right below the screenshot, I’ve calculated all of the default percentages, so you can see that the default rates correspond very well with the grade of the loan (i.e. “A” is the best, “G” is the worst).

    Hope that makes sense, but let me know if you have any other questions!

    [Reply]

  4. Hi –

    I have looked at the Lending Club, also Zopa, since I am in the UK.

    The problem I have is that I wouldn’t really call it an income, because it’s not, it’s an alternative to saving.

    And it’s only income if you invest a lot of money in to it. And even that will only last for length of the loan.

    If you invested $1000 in Lending Club for 3 years at 7% APR, your total profit will be $111.58

    Giving you nearly $31 a month. $28 of that you already had if you didn’t invest in Lending Club.

    Do you think it’s worth it? Unless you invest around $65,000 and get $2,000 back a month and $7,252 profit once the 3 years is up. You aren’t really generating income. In fact even with £65,000 invested, you’re only actually creating $200 monthly income.

    What are your thoughts?

    You’re website is interesting. Thanks for sharing!

    [Reply]

    Eric G. Reply:

    You have to look at it in a slightly different way. First of all, it IS income – that is a fact. You are earning money, which by definition, is income.

    However, it will definitely never be substantial enough to be your entire income. It’s a form of investing, and it’s a good way to diversify your portfolio. You obviously don’t want to put all of your savings in there, but if you can earn 7% at Lending Club vs. 0.5% in savings account, it makes sense to put some money there if you’re willing to take on the modest risk.

    Also, as you earn interest, you can reinvest it into new loans. If you do this, you won’t have idle cash sitting there, not earning interest.

    Again, you need to look at this as a way to diversify your income. If you have $20,000 to save or invest, it makes sense to reduce your risk by diversifying. You don’t necessarily want all of that money sitting in a super low interest-bearing savings account, but you also don’t want to throw it all into a volatile stock market. Lending Club is just one way to add to your diversification plan.

    [Reply]

  5. “The problem I have is that I wouldn’t really call it an income, because it’s not, it’s an alternative to saving.”

    Well, any income requires some sort of initial investment. When you work for somebody, your initial investment is time and for something like Lending Club / Prosper, your initial investment is money. Think of it as a form of fixed income financial product. (Why do they call bonds fixed-INCOME products? Because they DO generate income.)

    I am not aware of any passive income (or active income) with zero initial investment.

    [Reply]

    Eric G. Reply:

    Completely agree – thanks for the comment, TJ!

    [Reply]

  6. Well this is just awesome. I have been seeing how interest on loans can really take a toll on somebodies money. I was thinking to myself man I would like to be on the other side of that! I am going to join up with that in the very near future.
    Steven Papas recently posted… Webhosting Plans

    [Reply]

    Eric G. Reply:

    Nice! Yeah, it’s great to be on the other side, earning the interest. I’ve been very happy with it so far.

    [Reply]

  7. The one thing I see being difficult would be taxes. Do you have to fill out paper work for every single investment you made to prove you did or didn’t make profit and pay a certain percent on it?

    Besides that I think it’s a great investment tool.

    [Reply]

    Eric G. Reply:

    Nope, you wouldn’t need to worry about that. These investments don’t change in value assuming you hold them for the duration of the loan. All you have to pay tax on is interest you earn, which is as simple as running a report at the end of the year to see the total interest earned.

    [Reply]

  8. Hi, I even run into B rated notes which went into trouble. However I agree that the risk is very low thanks to diversification (strictly investing no more than $25 per loan) and also I am able to detect a loan which is a potential trouble and sell it on secondary market before it actually gets into the trouble, so my risk is even lower than $25 per loan. Sometimes I am selling at discount, so losing a dollar or two, but recovering 23 to 24 dollars of a note which later gets late or even defaults (I usually save the link to the note so even when I do not own it I still can watch the history of the note). My return is now at 13.08% and rising. You can see the results on my website.
    Martin recently posted… How to avoid tax problems

    [Reply]

  9. How do you feel about Kiva and other microloan/socially conscious loan sites and programs?

    [Reply]

    Eric G. Reply:

    I think they’re a good idea, but I haven’t personally used them. My guess is Lending Club is less risky though.

    [Reply]

  10. HI Eric, I am wondering if you live in a state where the “Financial Suitability” clause is in effect? I live in California where I must have a minimum of $85k gross income (and $85k in liquid assets) in order to participate as a lender in Lending Club. I might have counted the equity in my home, which is significantly more than the minimum, but according to the statement it’s not valid.

    [Reply]

    Eric G. Reply:

    Hi Wes, I don’t believe I live in a state with the “Financial Suitability” clause, as I’m not very familiar with that. Hopefully you’re still able to use Lending Club just fine.

    [Reply]

  11. Hi Eric,
    I absolutely love your website. I just discovered it and love all these tips you share. I’m still young so I guess I can’t do all of these tips. Great job and good luck with this great website.
    Thanks,
    Kurt

    [Reply]

    Eric G. Reply:

    Thanks Kurt – best of luck to you!

    [Reply]

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