As much as you try to automate a business, you will likely still need some involvement (even if it’s only 4 hours a week). Truly passive income can generally only be found with investments – stocks, bonds, saving accounts, rental property, etc. One issue we run into with investments right now is that safe investments have very low returns (1-2%) and riskier investments are highly volatile, but have the potential for higher returns. Most of us are aware of the fact that risk and return are highly correlated.
This isn’t an investment or finance blog, but I owe it to you and myself to examine possible sources of automated or passive income. Keep reading, because there’s free money in it for you.
For the past year, I’ve invested a relatively small portion of my portfolio (~$1,000) in Lending Club. I was skeptical at first, but my experiences so far have led me to believe that this is a great place to invest a small portion of your money. Let me emphasize: I am not recommending anyone to put all of their eggs in the the Lending Club basket.
Who They Are and How It Works
Lending Club brokers loans like a bank. Borrowers fill out an application, and if approved, Lending Club calculates a loan interest rate appropriate for the borrower’s risk profile (credit rating, current income, etc.). As you would expect, riskier borrowers have to pay a higher interest rate.
Instead of the process stopping there like it does with some banks, Lending Club turns around and offers to split up the loan and allow others to invest in it for as little as $25. Currently, they boast an average investor return of 9.65%, which is incredible compared to your other passive investment options. Here’s a slightly outdated image from their site illustrating how they can offer a much better deal than a traditional bank:
Example: Let’s say Mr. Borrower has an excellent credit rating and wants to renovate his kitchen, but doesn’t want to put the expenses on a high interest rate credit card or take out a costly loan from a regular bank. He might go to Lending Club and ask for a $10,000 loan. Because of his high income and good credit history, Lending Club offers the loan at a rate of 8.5%. Then, Lending Club turns around and allows YOU to invest in the loan, earning an interest rate of 7.5%. The 1% spread is how Lending Club makes its money, but more importantly, you’re now earning 7.5% (compare to the likely 1% interest rate of your savings account) on a relatively low risk investment. Remember, you can invest in the loan for as little as $25. The loan begins once the borrow receives the full $10,000 of funding (so if you invest $25, there will still be $9,975 that needs to be funded by others).
All loans have a 3-year term, but that doesn’t mean you wait 3 years to see your money. Loan payments are made monthly, so you can expect to receive monthly payments that include a piece of the amount you lent, plus interest.
How Credible Is Lending Club and What’s the Risk?
Currently, Lending Club has funded close to 9,000 loans. More importantly, they have declined 88,124 loans. As you can see, they do their homework before giving someone a loan. Currently the average interest rate is 12.64%, and the average default rate (rate of loans that borrowers are unable to repay) is a minuscule 2.6%. So, they calculate the average net return to be 9.65%.
If you follow my “method” of using Lending Club below, you’ll find your risk of not receiving payments on the loans to be far less than 2.6%.
My Experience with Lending Club and How I Recommend Using It
So far, I’ve had a great experience with Lending Club. Currently, my net annualized return is approximately 10%, far exceeding the rate I am earning in any of my savings accounts. Obviously, this isn’t risk-free interest, so let’s break down the filters I use when picking out loans to invest in, so that I can minimize my risk:
First, instead of going through Lending Club’s wizard where they will recommend loans for you, I like to click “Browse Notes.”
Next, I apply the filters shown in the image below:
- $25 per note: The logic behind this is to have maximum diversification in your portfolio. If you are working with $1,000, you would invest in 40 different loans. The downside risk is minimized – if a loan defaults, you only lose $25.
- 0 Delinquencies in the last 2 years: This is simple. A borrower who hasn’t had recent delinquencies is less risky for you.
- 10% Max Debt-to-Income Ratio: In other words, of the borrower’s total monthly income, this is the portion that the borrower has to pay each month for other debt/loans. You want this to be as low as possible so that the borrower has enough disposable income to pay back your loan.
- A and B Grade Loans: These are ratings given by Lending Club to the loans, based on their assessment of the borrower’s riskiness. Surprise! The higher quality loans have lower interest rates. We’re looking for more risk-averse passive income, so I like to limit my loans to A and B grade loans. Every once in a rare while, I’ll see a grade C or D loan that looks decent and I’ll invest. It’s okay to take risks – just understand what the risk entails.
- Credit Score 714+ : Again, we like less risky borrowers.
- Exclude loans invested in: I only like to invest $25 max. in a single loan.
- The Intangibles: Even if the the loan meets your criteria, read the description for what the loan is for – if it sounds stupid to you or the borrower seems shady, don’t invest.
After applying these filters, you will notice that your loan options are limited. Sometimes, you may only see 5-10 loans that match the criteria. It may take a few weeks to fully invest your initial deposit (depending on how much that may be) assuming you stick to $25 loans.
One other note: Once you make your initial investments and buy 40 loans with $1,000, for example, you will want to check your account periodically. Remember, loan payments are made monthly – it won’t be long before the cash in your account accumulates to $25+ and you can invest in another loan. You don’t want idle cash in your account (unless there are no good loans to invest in).
Sign Up Now and Get Some Free Money to Invest
What are you waiting for? This is a great way to earn a little bit of passive income while you work on your business or work through the 9-5 grind. The best part is, if you sign up with this link, you get a free $25 to invest.
Still unsure and have some questions? Feel free to email me and I’ll do my best to help you out.
30-Day Challenge Update – Day 10 (2/4):
Day 10 Total $ 0.00
30-Day Challenge Update – Day 9 (2/3):
Coffee/Breakfast: $ 2.75
Day 9 Total $ 2.75
30-Day Challenge Expense Total: $135.55
“Allowed” Expenses Remaining $364.45
Average Daily Expense to Date: $13.55 (Target Average: $16.67/day)