Lending Club – 3 Years of Peer-to-Peer Lending

by Mr. Cheap

Three years ago I got into Lending Club with an American friend of mine (she could open the account, whereas I couldn’t).  This is a summary of my experiences.

Three years is a reasonable length of time to get a feel for a new investment vehicle like this, as this is the time length of loans Lending Club provides.  I’ve had people pay on time every month, pay late then get caught up, pay off their debt early and borrowers default on their debt – the full range of what can happen.  I’ve gained an understanding of why banks are as risk-adverse as they are (and am amazed that bankers don’t hate everybody – the amount of deceit in loan applications is shocking).

The concept behind peer-to-peer lending (I describe it to friends as “E*Bay for loans”) is that the company (Lending Club) acts as the middle man for lending between people.  Borrowers post a request for money, then lenders “bid” on how much they’ll loan that person, and at what interest rate.  Say I ask for a loan of $100 and Mike offers $60 at 12%, Squawkfox offers me $25 at 8% and the Canadian Capitalist offers me $75 at 10%.  The loan will be arranged at 8% 12% 10% between Squawkfox & CC (Mike will have been underbid) and myself.  Lending Club handles the loan documents, processing payments and discharging bad debts (so neither the lenders nor the borrowers need to understand the full legality of lending money – the company takes care of that).

Lending Club makes its money by taking a cut of the loan when it’s issued then taking a small portion from every payment.

Initially my friend and I put in $250 each, quickly loaned this out and were happy to see our account value growing from the high interest rate (and consistent repayments).  I congratulated my friend on how skilled we were in evaluating borrowers (since we hadn’t had a single default or late payment) and suggested we leverage her strong credit to borrow money from Lending Club to re-lend (with friends like Mr. Cheap, who needs enemies?).

Come August 2006, we borrowed  $2,500 and were quickly able to lend it out again.  We decided to pour all the repayments into early pay off of the debt (and were talking about starting lending again once the debt was repaid).  Projections looked good, and I was bragging to my friend (and other people I told about the concept / website) how we’d be making money unless there were a massive number of defaults.  On the forums, people were happily cackling about how much cash they were making and we were all patting ourselves on the back for getting in on such a good thing early.

Of course, that’s when the massive number of defaults hit.  Some lenders had talked about the insanely low rates that had been offered in the early days of Prosper (when there were far too many lenders and loans got bid down to very low rates).  Of course, we’d all done the exact same thing (and just didn’t realize it at the time).  Some new lenders were bragging in the forums about how skilful they were that they hadn’t had a single late payment or default (after two whole months!) and the old guard started to warn them to just wait, they soon would.

In April 2009 we paid off the last payment on our $2,500 loan (which had MOSTLY been covered by debt repayments, but we’d had to transfer in small amounts to cover it twice).  We put a total of about $660 into the account, and it’s currently valued at $318.62 ($234.91 in loans, some of which will probably default, and $83.71 in cash).  This is a LOSS of 48% 52% over 3 years.

Of the 50 loans we made, 12 have been paid back, 20 have been charged off (defaulted and sold for pennies on the dollar to a collection agency), 14 are current (payments up to date) and 4 are past due (and VERY likely to be charged off, two are heading to bankruptcy and I’m pretty pessimistic about the 3rd, which is 3 months late).  The one person that REALLY burned us was a fire fighter who had excellent credit, borrowed the money and never paid a single cent towards it (to me this was clearly fraud).

Some might argue that we must have been scraping the bottom of the barrel for loans, but this wasn’t the case.  Our portfolio was a mixture of A’s, B’s and C’s (we avoided people with lower credit scores).  We also ruled out people who had gone through bankruptcy or had a number of delinquencies on their credit report.  In spite of this, we had MASSIVE defaults BEFORE the financial crisis hit.

Another friend borrowed a few thousand from Prosper to start a business and got an excellent rate and got the loan more easily than getting a comparable loan from a bank (and at a very decent rate).

In summary, I would say first and foremost that investing with Mr. Cheap is almost always a bad idea (I should start a hedge fund and you can all short it!).  Peer-to-peer lending is an exciting concept, but the risk is currently being mispriced (in my opinion).  The rational response to this is to use these service as a BORROWER, not a lender.  If enough people do this, perhaps these services will get better at pricing risk and a fair reward will be offered for the risk the lenders are accepting.

Peer-to-peer lenders include Prosper and Lending Club in the US, Community Lend here in Canada and Zopa in the UK.


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