The Plunge into P2P Lending
Thanks to a post at Write Your Own Reality (WYOR) entitled, Using P2P Lending to Protect Against Short-Term Cash Needs, I decided to look into it a little more thoroughly.
I first heard about it from a friend at work who has invested about $15,000 over the last few years. He’s had great success so far and is averaging over 9% interest per year. 9% per year isn’t bad at all, though with the roaring markets of the last few years, he did lose compared to what he could have made had he stayed only in stocks. However, 9% annualized over a number of years still is really good.
I had a choice between Lending Club and Prosper to start out with. Both companies are available to lenders in my state so I ended up picking Lending Club since it had more loans available and more people seemed familiar with it. Both are very well reviewed and most serious P2P lenders are invested in both.
The way this P2P, which stands for person-to-person, lending works is that Lending Club connects persons buying a loan to people willing to fund that loan. Lending Club does the leg work like determining an appropriate interest rate for each loan given credit history, income, etc and will pursue legal means to collect unpaid debts as well. The people borrowing the money know that failure to pay on time does come with consequences as these things are reported to the credit bureaus.
For instance, someone might come to Lending Club looking for a loan to pay off credit card debt. As we all know, credit card interest payments could be in the 20% range. At Lending Club, he might be able to get a $25,000 loan at a 12% interest rate. It is a win-win scenario. The person buying the loan saves money while the people lending him the money get a nice interest payment.
In the case of the $25,000 loan, there may be as many as 1000 people investing in that loan at $25 per note. $25 is the minimum investment per note while the maximum is up to $200, I believe.
So what I recently did was send Lending Club $2000 and use that to buy 80 notes (80 x $25 per note). Lending Club recommends investing in at least 100 notes because the more notes you invest in, the less a default ends up hurting. With my 80 notes, 1 default would amount to a loss of nearly 1.3%, not too bad but definitely not ideal. You’d hope that the individual defaulting would have at least made a few interest or capital repayments along the way, making the loss a little less. The likelihood of a complete default and write-off is there, but the risk is mitigated by purchasing more notes. Lending Club also has extended grace periods as well as debt collecting agencies available to recover as much of the loan as possible in these cases.
For statistics on loan performance visit the Investor Account Performance page on Lending Club Statistics. There is also a third-party site run by Nickel Steamroller that tracks P2P Lending statistics.
So now with $2000 in cash available I eagerly browsed the available loans. I used the simple filter that WYOR recommended here.
That filter includes:
- Loan type: Credit Card Refinance and Debt Consolidation
- Inquiries Last Six Months: Zero
- Monthly Income: Greater than $5,500
- and I added, Delinquencies (Last 2 yrs): 0
There were plenty of loans to choose from, ranging from A Grade at around upper 5% to even a few C/D’s at 15%. If loans matching your desired criteria are not available, just check back later in the day or the next day. Hundreds of loans are added daily.
Over a few day period I purchased all 80 notes and waited. And then waited some more. My main complaint so far is that it takes awhile for a note to actually be issued. Each loan remains open until it gets funded. However, the money may be returned should the borrower cancel the loan request, submit an incomplete application, or fail to provide information requested. In those cases, the cash I committed to that note is returned to me and I can use it to invest in a different note. Then you wait again. The thing I don’t like about it is that all the notes that are in this limbo period are not doing anything for you: no interest is being earned, no dividends collected.
I’d have to look through my statements, but the average wait time is probably around a week or so for me. That’s what Lending Club quotes as well so I doubt that this delay is atypical.
Now to the good stuff. Interest payments and repayment of principal. I have not yet invested in any bonds, but this is one of the main benefits that P2P lending has over bonds. As soon as $25 in cash is available in your account (from a combination of interest and/or principal repayments), you can immediately (well, okay, with that delay I talked about) invest in another $25 note. This then helps accelerate compounding.
I started my account with $1500 committed to notes on 2/26/2015 and then on 3/16/2015 added an additional $500. As of today, my expected monthly payments are $64.99. I have received $49.18 in payments to date, which includes $36.66 in principal and $12.51 in interest. From now on I’ll include that interest figure in my monthly income posts.
The really cool part of this is that I can turn around and take that $64.99 and use it to buy 2 additional notes per month. And then those 2 additional notes will help bump up that figure even more. Soon I’ll be able to buy 3 additional notes per month. This can go on ad infinitum until I decide that I wish to cash out or maybe need the cash flow for other things. I’m not only compounding my interest and principal repayments, I’m also decreasing my overall risk.
By choosing to lend to 36-month notes, the payments of principal and interest will be higher than lending to 60-month notes.
With 36-month notes, an investor receives about 35-37% per year. That comes out to about 3% per month in repayment of principal and interest payments. I’m close to that mark currently. $64.99 per month / $2000 = 3.2%.
For my friend with the $15,000 invested, that comes out to just under $500 in cash flow per month should he choose to not reinvest it. He’d be able take that out to help pay rent, gas, groceries, or other expenses.
They always say that you should keep an emergency fund for at least 3 months of bills. Let’s say you’d need $3000 a month. One option would be to store $9000 in a savings account. Then its gone after three months. Another would be to invest $100,000 with Lending Club, creating a monthly cash flow of around $3000.
If you don’t need the money, you can just keep reinvesting it back into more notes to increase the compounding effects. Should you run into an issue where you temporarily need that cash flow, then you’d just turn off the automatic reinvestment and instead get that money deposited into your checking account. It would provide around 3 years of a $3000 monthly cash flow.
I also know a person that likes to keep three years of annual income in cash in case there’s an extended drop in the stock market. This person is retired yet is still mostly invested in stocks (rather than the “recommended” bonds at his age). Let’s say he wants $100,000 per year so keeps $300,000 in cash equivalents. That’s a ton of money that has earned close to nothing over that last few years. If he’d like to receive the equivalent in annual cash flow with Lending Club, he’d have to invest around $278,000. That amount would deliver roughly $8340 per month in cash flow. Given that he doesn’t need the money now, he’d just keep reinvesting it back into Lending Club, letting compounding work its magic. If the market takes another drop, then he’d just redirect the cash flow into his checking account and wait for a stock market recovery.
I’ll be including the interest payments on the loans as part of my monthly income updates.
I can definitely see P2P lending becoming a supplement to my current strategy of dividend growth stocks and options trading. $2000 is a little over 1% of my total portfolio so far. Lending Club recommends that they be not more than 10% of any investing strategy; I’m planning on keeping it well under that percent.
I’m excited to see how this P2P lending works. It’s sort of an experiment for me at this point. If it didn’t allow the monthly compounding with the purchase of more notes, I wouldn’t be nearly as excited.
Here’s some light reading that is quite interesting (and for a later discussion): What will P2P lending look like 5 years from now?