In April 2018, I made a peer to peer lending account on Lending Club.
I was talking with my buddy who was also on this journey to financial independence.
He told me how there’s this saying that goes something like, “Rich people have at least 7 sources of income.”
Because a part of growing wealth and having super FU money is to grow and diversify your income stream.
I then started counting my sources of income:
- Savings Account Interest Rate
- Stocks in Robinhood/ETrade
[Currently as I update this in November 2018, I realize how silly I was back then to think that those were 7 different sources of income when they were pretty much the same thing. Stocks. Now I’m trying to diversify into different facets of businesses, not stocks. But that’s a blog post for another day].
I didn’t have a 7th source of income so my friend recommended I try peer-to-peer (P2P) lending.
I had heard of it before and always wanted to try it but was always “too busy” to make an account.
He then gave me his affiliate link to Lending Club and I checked it out.
Basically, at the time of this writing, if you use my invite link to Lending Club, I will get a $75 referral commission if you put in $5,000 or more.
Shameless plug, click my invite link for Lending Club here.
You need at least a $1,000 minimum to open a Lending Club P2P account and that was the amount I deposited into it.
The stocks in my Robinhood brokerage account had grown considerably in the past year (thanks to Netflix and other tech stocks lol), so I thought I would sell out of some and move that $1,000 to Lending Club.
Robinhood also doesn’t have any minimum required to open an account.
If you want to make an account, use my Robinhood invite link here.
If you click on my Robinhood invite link, at the time of this writing, Robinhood says that they will give us both a stock of a public company, e.g., Berkshire Hathaway, Apple, Facebook, etc.
I also recommend Robinhood to trade stocks because they don’t charge a $10 commission to trade like other platforms, *cough* Etrade *cough*. Robinhood doesn’t charge commissions to trade.
Do your research first.
Before I started investing the $1,000, I made sure to read up on how other successful financial independence and personal finance bloggers have done with Lending Club.
Here are 4 articles that I read and want to share with you from Mr. Money Mustache and ESI Money.
They said don’t do it.
They both pretty much agreed not to do Lending Club and their returns weren’t worth it over the several years that they were in Lending Club.
And if I understood their numbers, they also said that eventually, in later years, they lost whatever gains they made in earlier years.
Loses came from defaults or people not paying their dues, etc.
Last time I checked both of their blogs, they said they were moving out their tens of thousands of dollars from Lending Club.
I noticed, however, that the majority of their investments were in the middle grade section in order to maximize returns while factoring in for defaults.
I wanted to do it a little bit different.
You see, the person’s loan request gets broken down into bite-sized pieces called “Notes.” The smallest note that you can buy is $25.
So if someone had a $1000 loan that they are using to, for example, refinance something, that $1000 is made up of 40 notes of $25 each.
As the P2P lender, you can choose to fund all $1000 of their loan, or a fraction of it, as many notes as you want that are available.
How did I invest the $1000?
For me, with $1000, I would at most, be able to get 40 notes.
An A grade means the “safest” or least likely the person is going to default on their loan.
The lower the grade, the riskier it gets and the more likely the person’s going to default on their loan and you lose the money you invested.
The interest rates will reflect the safety of the loan grade.
An A grade loan will give you less interest than something toward the E grade.
You can also think of it this way.
Grade A loans come from people with decently good credit scores, and people with decently good credit scores tend to get lower interest rates because they’re more reliable with payments.
Hence you’ll receive a lower interest payment from them.
The opposite happens for the lower grades because the people refinancing have a lower credit score.
This signals that they are not as dependable to pay back on time, hence a higher interest rate.
Yes, this system really does seem like it screws over the person with the bad credit, because charging them the higher interest makes it more likely that they’ll default on their payments because of the crushing interest payments, thus perpetuating a vicious debt and low credit cycle.
I won’t get into the nitty gritty of the risk-reward rations here.
I just gosh darn wanted to talk about the notes investment ratios next!
Here ya go. This was my original idea to spread them, kind of like the weighted index of the S&P500, where the reliable ones at the top get more weight.
- A: 30%
- B: 25%
- C: 20%
- D: 15%
- E: 10%
Total: 100%, skewing toward the A grade majority while still having a decent interest rate from the middle grades.
With this percentage ratio, because I have a total of 40 x $25 notes for $1000, it would be divided up as:
- A = 12 notes
- B = 10 notes
- C = 8 notes
- D = 6 notes
- E = 4 notes
But wait, there’s more!
After reading Mr. Money Mustache and how he divided it using Lending Club’s own algorithms, I decided that maybe I should look more closely into this and came up with another spread idea:
- A: 20%
- B: 20%
- C: 20%
- D: 20%
- E: 20%
The reason being that it seems like the default risk spares no one, regardless of the grade of the loan.
With this ratio, the amount would be an even 8 notes per grade.
But in the end, I think Mr. Money Mustache considers all of this more or less “witchcraft” according to the wording he used in his Lending Club observations of other people’s explanations lol.
In the end, theory is theory.
I like the application part.
So let’s apply it according to the even 20% split across all grades and see where we go.
I will be updating this at irregular intervals in the future to let you all know how it goes!
Questions to ask yourself before you start investing in peer to peer lending.
I’m still a little on the fence with this but it all boils down to a couple of questions that you have to ask yourself:
- How much are you willing to lose? Assume you lose 50% of your investment, will you still be okay? How about an 80% loss? What if you lose all of it?
- At what return will it be enough for you? I ask this question because my dad brought up a good point for me when talking about Thai stock traders. They don’t know when enough is enough, and they keep investing until one false move and they lose not only their shirt, but their house and their livelihood, then they kill their families and themselves to escape the horrible tragedy they put themselves in.
- What rate of return is enough for you? If you get roughly a 6% return annually after it’s said and done (after defaults, taxes, etc.), your money reinvested should double in 12 years.
- Are you okay with that?
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