Long time readers of this blog will know about my love of the number of inquiries filter. I have talked about it a great deal but I have never explained in detail why I use this as my primary filter when choosing loans.
Today, I will give you some analysis that will back up my claims about this filter. But first let’s explain what I mean by number of inquiries. This is something that is recorded on everyone’s credit report and is used by Lending Club and Prosper in their underwriting. When you apply for a credit card, a car loan, a home loan or almost any other kind of loan your credit report gets marked with an inquiry. Any loan application where they do what is called a hard pull of your credit will stay on your credit report for six months.
What is interesting to me is that when you filter loans on the number of inquiries you find that the more inquiries a borrower has the more likely they are to default and the lower your expected ROI is going to be. This rings true for both Lending Club and Prosper borrowers. Here are the numbers for Lending Club. Keep in mind I am only looking at data from July 2009 onwards and, as always, I used data from Lendstats to create these charts.
Lending Club Analysis[table "13" not found /]
If you choose all loan grades on Lending Club that have zero inquiries on their credit report, according to Lendstats, you can expect a 7.84% ROI (as of this writing) on your money. Then for each additional inquiry the ROI goes down and the default rate goes up. This trend gets even more noticeable when inquiries are greater than three.
The number of credit inquiries has an even bigger difference when you look the lower grade (higher risk) loans. When taking grades D-G only on Lending Club you can see that the range is from 9.21% down to 7.63%. I didn’t include the numbers for Grades D-G for inquiries >= 4 because there were only 53 loans on the entire database so it wasn’t a large enough sample to give meaningful data.
Prosper Analysis[table "14" not found /]
We find the same trend on Prosper (using data from July 2009 onwards) although admittedly it is not quite as marked. But for every additional inquiry that a borrower makes on their account we see the same linear progression: estimated ROI goes down and default rate goes up. And if you are investing in higher risk loans then again the difference is even more noticeable.
This Makes Logical Sense
When you think about it, this makes logical sense. If someone is out shopping for credit in several places and then they come to Lending Club or Prosper looking for a loan then they are a higher risk borrower. They may have some serious financial problems if they are shopping for a lot of credit. But if someone is looking for a loan and comes to p2p lending first then they are a better credit risk. One inquiry on a credit report doesn’t make a big difference but the numbers show that these borrowers are still a higher risk than borrowers with no inquiries at all in the past six months.
This is why I continue to make the number of inquiries a key part of my investment strategy and I encourage other investors to do the same.
[Update: several people indicated that the above charts gave an unclear indication of the differences between number of inquiries because I wasn’t isolating each inquiry number in my analysis. So in order to give a complete picture for investors I have redone the charts below with the number of inquiries isolated (as in inquiries = 1 instead of inquiries <= 1). The same trends still apply although it is not quite as linear. Please note that the charts below were created on a different day to the original charts which is why the numbers for inquiries = 0 and inquiries >= 4 are slightly different.]