Wednesday, August 06, 2014

Buying Notes on Lending Club--New or Old?

So, you've been reading my posts about Lending Club, and now you want to try it.  What do you do?  First, you have to open an account at Lending Club.  Next, you have to send them money.  While there is no minimum balance requirement, new notes cost at least $25.00.  Lending Club recommends a minimum investment of $2,500 to decrease volatility.  I chose to use $1,000.  It takes about four days after they receive your money for it to be credited to our account and ready to invest.

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Used with permission

New Notes or Old?

The first thing you have to decide is whether to buy newly issued notes or notes from the resale market.

Advantages of new notes:  

  • You get the highest interest from the new notes, unless you are willing to take a chance on a note that someone considers a problem.
  • The information you have on the borrower is fresh, and has been checked by Lending Club.
  •  The biggest interest payments come at the beginning of the loan so fees are less in proportion to what you receive.  What I mean by that is that Lending Club takes 1% of every payment made by a borrower.  Most of my $25 notes pay me about 85 cents per month, meaning that Lending Club takes about a penny.  If it is at the beginning of the loan, much of that 85 cents is interest; toward the end of the loan only a few cents is.  If the interest portion of the payment is 70 cents, you've paid 1/70th of your income to Lending Club; if the interest portion of the payment is only 5 cents, you've paid 1/5 of your income to them.
  • You can  use automatic tools to invest.  Lending Club has tools you can tell the type of note you want, and whenever there is enough spare cash in your account, the computer will buy you another note.  If you use this tool, Lending Club is a passive investment; without it, as your account gets bigger you will spend a lot of time searching for and selecting notes.
  • You can open an IRA.  For whatever reason, resale notes are not allowed in an IRA account.

Advantages of resale notes:  

  • They cost less.  If you have a limited amount of money to invest, you can get more resale notes than new ones.  The more notes you have, the less one default will affect your returns.
  • You can see a payment history.  In general, the longer a borrower has been paying without a problem, the lower the chance of a default.  I've read that there are basically three reasons borrowers default: 1) Fraud--they never had any intention of paying back the loan.  These borrowers typically make no payments, or at the most, one or two payments.  2) They bit off more than they can chew.  The bottom line is that unless life goes perfectly and this note is the priority, the borrower can't afford the payment.  This borrower shows a pattern of late payments, missed payments etc. and these problems generally show up in the first year.  3) The borrower has a real crisis in life--a layoff, a breadwinner in the hospital, a natural disaster--and who knows what else, but the bottom line is that something big happened and now the borrower's financial status is changed.  Unfortunately that can happen at any point in the loan's life cycle.  While you cannot predict the crisis, Lending Club's statistics show that most defaults happen, or at least get started, in the first year of a loan's life.  If you purchase a loan older than that, you've eliminated much of the default risk--and the seller realizes that and generally asks a premium price.
  • You can buy them no matter where you live.  Some states do not allow the purchase of new notes, but do allow the purchase of resale notes.  Don't ask me why.
  • They put your money to work faster.  I'm writing this on July 26.  My money was ready to use on July 10.  As of today, I still have $100 of the $500 I put toward new notes that is not invested, and which is therefore not earning me anything.  The fact that I am willing to invest $25 in a loan does not mean it will positively be approved, or that the borrower will make the decision to accept the proffered loan if it is approved.  As a result, I've had several loans that I chose not be completed.  If that happens, the money goes back into my account to be reinvested.  Until everything is complete, no interest is earned. If the four notes that are in process all go through, they'll start earning interest in a few days.  If one or more do not, then it will be almost a week more before that money starts working.   As of today, I've been paid $1.11 interest on my resale loans and nothing on the new ones (first payment isn't due for 30 days).  The $500 I put toward resale notes has been fully invested for over a week.  

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