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Guide to Social Lending Networks

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Certificate of deposit rates are abysmal, high yield savings account interest rates are worse, and the stock market is insanely volatile… which is why so many people have started to turn towards social lending networks like LendingClub, Prosper and Pertuity Direct.

What is Social Lending?

Imagine you are in need of some money, where can you turn? You can go to a bank but the paperwork would take weeks. You could rely on your credit cards, but cash advance fees are very high and the interest rates are even higher. You could always turn to friends and family… but if you’re talking more than a few hundred dollars, your friends and family may not have the means to loan you that money. Where can you? Not many places… which is why social lending has simply exploded in popularity.

Social lending networks gives borrowers a place to place “ads” that explain their situation and helps them solicit funds for their needs. That’s where “investors” come in, they bid on those auctions and buy debt, hoping to earn money on the back end through interest payments.

Social Lending Networks

There are several social lending networks but the big three networks in the United States are LendingClub, Prosper, and Pertuity Direct.

LendingClub

At LendingClub, the rates start at 7.88% on loans, which means you, as an investor, could earn anywhere from 6.69% to 19.37%. Each loan is given a Lending Club grade that ranges from A1 to G5, with A1 being the best rate of 7.37% and G5 being the worst at 20.11%. LendingClub earns money through a processing fee charged to the borrower which ranges from 0.75% for “A” borrowers and 3.50% for “G” borrowers (here’s how they set the rates).

Borrower requirements: For someone to be qualify as a borrower, they must be have a FICO score of at least 660, a debt-to-income ratio (excluding mortgage) below 25%, have at least 1 year of credit history with no current delinquencies, recent bankruptcies, open tax liens, charge-offs, or collections in the last 12 months; no more than 10 inquiries in the last 6 months, revolving credit utilization of less than 100%, and more than 3 accounts on the report, of which 2 must be open.

Prosper

Prosper was the first of the social lending networks to hit it big in terms of popularity but they’ve recently entered into a “quiet period,” as they register with the proper federal and state agencies. When they exit the quiet period, I’ll add more to the description because at the moment they cannot take new lender registrations or allow new commitments from existing lenders. In other words, they can’t do anything except service the loans they’ve already set up.

Pertuity Direct

Pertuity Direct is another social lending network that has exited the quiet period and works slightly differently. Investors buy into the National Retail Fund (a mutual fund that sports a 2.83% expense ratio before waivers, you can read its prospectus here) and the fund invests in loans from borrowers. It offers broad diversification over the entire pool of borrowers at Pertuity Direct but none of the selection. As a borrower, you simply apply for a loan and the administrators decide whether you qualify and at what rate, with rates ranging from 8.9% – 17.9%.

Borrower requirements: The only listed requirement is that borrowers must have a FICO score above 660.

Is Social Lending Right For You?

That depends! As social lending networks have evolved, the liquidity of your loans to other people has increased. In the beginning, when you bought into a loan, you had to hold it to maturity. Nowadays, you can sell it early or buy loans from other investors after they’ve been funded (this is what triggered the quiet periods).

If you invest with Pertuity Direct, you don’t have as much homework to do (read the prospectus and be aware of the fees). If you invest with LendingClub or Prosper, where you choose individual loans, you really have to be diligent about who you fund and how you structure your portfolio. Remember that higher interest rates are the result of higher risk, you need to structure your portfolio with that idea in mind. Some of those loans will default, you have to structure it so that the ones that don’t will pay you for the ones that do! (LendingClub lists their historical default rates with A’s average at 0.47% defaults and G’s having 5.21% defaults)

I wish LendingClub was available in Maryland because I’d love to give it a shot. I’m a firm believer of the model, especially with all the shenanigans the banks have done with repackaging loans, because it helps people meet their goals when traditional lending fails.

(Photo: nitrofive)

{ 14 comments, please add your thoughts now! }

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14 Responses to “Guide to Social Lending Networks”

  1. Eric says:

    I think it’s a good alternative to bank loans too.

  2. Matt Fyffe says:

    LendingClub sounds like a great opportunity but a very high risk. I’d love to see big gains on my money but I just don’t know how comfortable I feel lending my money out to complete strangers. Are there any fallback options if a personal fails on you to get some of your money back?

    • Jim says:

      Like a loan, the only option is to go into collections. The idea is that you diversify your loans so that the ones that don’t fail will compensate you for the ones that do, giving you an effective interest rate that matches your level of risk.

  3. I just funded my first loans with Lending Club last week, it was fun sorting through borrowers and deciding which ones I wanted to lend to. I’m not investing much, just a little play money on the side. We’ll see how these first loans do before I add more money. I chose only borrowers with really good credit, no delinquencies etc. This meant lower rates, I think the weighted average was around 10%. It sure beats the 1.5% ING is now paying.

  4. I would love to learn more about this. Being a lender with one of these companies sounds risky, but could have a huge payoff if people are dependable. Once I have a good chunk of change at my disposal, I may just try this…

  5. Amy says:

    It’s funny, your last paragraph mentions your interest in this because of the current bank situation — that’s exactly what interests me the most about this. When one system fails to meet the needs of society and the marketplace, another system can step into its place. I want to be part of that.

    Lending Club is not offered in my state, either, but residents of all states can participate in the note trading platform. (I live in Michigan.) I just got my account funded and now I can start building the portfolio. I’m not investing a lot, either. I want to see how it goes. But this really connects you more to borrowers than any other method I know. (Other than direct personal loans, of course, but that’s a whole different game.)

    If you want to get into this from a charity point of view, there is a website called kiva.com that does microloans to people in developing countries. You don’t get interest, so it’s not really an investment opportunity, but it works on a similar principal, and the intent is that you would get your money back in the end.

  6. Amy says:

    Sorry, that’s kiva.org.

    • Meg says:

      Thanks for the tip on the note trading platform being available to all states Amy. I wanted to give Lending Club (and Prosper when it comes out of it’s quiet period) a shot but went with Pertuity Direct due to location restrictions. (I live in N.C.) I’m not investing much either but I would like to compare the services because they seem to take a different approach.

      Also, eBay owns a fantastic little company called MicroPlace that is very similar to kiva.org but offers interest. There is no charge to fund an account through PayPal either. I have been “donating” (I feel like a loan that is tied up for years without interest is more like a donation even if you do receive it back) to kiva for a few years but discovered MicroPlace recently and decided to move my socially responsible investments there due to the interest that is possible.

  7. RobertD says:

    It sounds nice, but is it?

    Firstly the rates they are charging are higher then those of banks. So how do they get the best borrowers, you would have to be stupid to knowingly pay more money just to avoid a bank.

    Second the default rates they claim seem low. Canadian banks, (Canada has stricter banking laws) assume higher default rates.

    What do collections cost? If you have ever placed an unsecured debt for collection, you would realize that when the economy was good you wold only collect 50%, so what do you think will happen today.

    Try to sell those loans when the economy turns around, and interest rates raise. Just like trying to sell a low interest bond during high interest times you sell them for a discount.

    For assuming zero risk these people are getting a great spread, every bit as good as a bank gets on three year money.

    I know these comments are rather negative, but someone needs to point out the downside or you fall into dangerous traps.

    If you ask me a bunch of bankers have figured out a way to bank without assuming any risk.

    Remember if you do not know everything about any investment you should avoid it. Personal unsecured lending is the highest risk type of lending there is, and thus the highest risk investment you could take.

    There are all sorts of low risk bonds and solid stocks that in the log run will return every bit as well. And at today’s price there are bargains to be had. Short term greed can lead to long term pain.

    • BrewCrewFan says:

      Excellent post. The banks have shown how challenging it can be to profitably underwrite loan in this environment. I’m going to sit on the sidelines until I can these programs develop a longer track record.

  8. Eric says:

    What kind of returns can be expected from investing in Pertuity Direct’s fund? According to this site the average interest rate of the loans is 13.5%.

    Is the return on investment simply this 13.5% minus the expense ratio of 1.63% for the first year and 2.83% thereafter?

    see also

  9. Jonathan says:

    I’m also curious to see where P2P lending goes in light of the current economic situation. I’m confident in LendingClub, but I wonder if current mistrust in banks will cause a rise in P2P lending or have folks keep their distance. LendingClub seems to have reasonable safeguards in place to prevent defaults, but as with everything else, there’s no absolute guarantee.

  10. Casey says:

    I lent with Prosper before they began their “quiet period” and I’ve been sorely disappointed as have most other lenders I talk to on the Prosper forums. About 20% of my loans have defaulted, several others are late, and Prosper has broken many promises regarding its collection process. I think I’ll be lucky to even see my principal money back by the end of this.

    Can’t say I’m sorry I tried it out, but can’t say I’d do it again.

  11. Eric says:

    I also went with prosper and I do not recommend that anyone go with the social lending networks. I’ve lost over 3/4 of what I “invested” and probably won’t get that last quarter either. Stick with cds.


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