How I Invest in Lending Club and Prosper

When I started investing in peer to peer lending in 2009 I have to admit I was pretty clueless about it. I started small and really didn’t do much research. Consequently my returns were not that great, dipping under 5% at one point.

Since then, I have learned a great deal about investing in both Lending Club and Prosper. And thanks to third party sites like Lendstats I have been able to do a ton of analysis using different filters to see what has worked in the past. Now, there is no guarantee that what worked in the past will continue to produce the best returns in the future but I believe the analysis is worthwhile and I continue to base my investment decisions on this analysis.

If you are unsure about any of the terms used in these filters you should learn about credit reports and the information they provide. Here are two pages that can help.

Lending Club Loan Filters

I have two accounts that I actively manage at Lending Club, I also have two Lending Club PRIME accounts in my wife’s name (a traditional and a Roth IRA) which I won’t be discussing here. For the two accounts I manage I use a different strategy for each. For my original Lending Club account, I have tried all kinds of filters but have settled on this relatively conservative strategy for a while now. Both strategies invest in 36 month as well as 60 month notes. I should also note that when I actually invest I download the current loans in a CSV file and do my filtering there.

Conservative Lending Club Strategy: B-C Grade Loans

My main account is now focused on B and C grade loans, I don’t invest in A grade loans because I don’t think the interest rates are high enough for investors. That is just a personal choice, A grade notes are popular with many investors. Here are the filters I currently use for my reinvestments on my main taxable account.

Credit Grade: B1-C5
Inquiries: 0
Total Lines: 10+
Revolving Debt: <=$16,000
Credit utilization: between 20% and 95%
2 year DQ’s: <=2
States excluding: CA, FL
Loan Purpose: all
Monthly income: $4,000+
Employee length: 4+ years

Here is link to these filters on Lendstats. As of today, the estimated ROI on loans with these filters is 10.5%. Now, I could go through the filters and discuss the relative merits of each one, but I have really just let the data dictate the filters. I have played around with different values and these are the best filters I have found for the B & C credit grades. You can get higher returns if you narrow down further, but I like to have a pool of at least 500 loans. Currently, Lendstats reports there have been 595 loans with these criteria funded since January 2007.

Aggressive Lending Club Strategy: D-G Grade Loans

For my new Lending Club IRA account that I opened in April I use a different set of filters. I focus on different loan grades here to avoid doubling up on any loan. I also have chosen a more aggressive strategy to see if I can achieve a higher ROI. I am focusing on the riskiest borrowers on Lending Club so this strategy will not be for everyone.

Credit Grade: D1-G5
Inquiries: 0
Open Lines: 6+
Total Lines: 15+
2 year DQ’s: <=2
Public Records: 0
States excluding: CA
Loan Purpose: credit card, debt consolidation, education, home improvement, house, moving, renewable energy, vacation, wedding
Employee length: 4+ years

The estimated ROI for these loans according to Lendstats is 13.37% with 492 loans meeting these criteria since January 2007.

Prosper Loan Filters

With Prosper I also have two sets of filters that I am running right now. Both are very aggressive, targeting just the higher risk loans. I do not use a conservative option on Prosper.

The way I look at it is this. Prosper allows access to a higher risk borrower than Lending Club, with allowable FICO scores down to 640 (660 is in the minimum on Lending Club) with the higher interest rates to match. On Lending Club G rated borrowers pay 22-23% interest. On Prosper most D, E and HR rated borrowers pay more than that. I try to diversify my peer to peer lending investments across both platforms with exposure to borrowers in most credit grades. So my Prosper investments are focused on these lower credit grades.

With all my analysis on Prosper, I only look at loans originated after Prosper reopened in July 2009. Prosper changed their risk management dramatically then, so I think there is little point in doing any analysis on loans from Prosper 1.0.

Aggressive Prosper Strategy 1: Previous Borrowers

As I mentioned in my recent post about previous borrowers on Prosper, I think this is the best category of borrowers as far as risk-reward goes in all of peer to peer lending. These are people with a proven track record of paying back a previous loan and this is where I am focusing most of my investments on Prosper. I use a pretty simple list of filters here:

Prosper rating: D, E, HR
Inquiries: <=1
Current DQ’s: <=1
Payments on previous loan: 24+
Late payments: <=1

According to Lendstats these loans have an estimated ROI of 22.78% and there have been 472 loans issued that meet the above criteria. Now, I don’t expect to net a 23% return on my investment in these loans, I expect there will be many more defaults as the loans age. Prosper estimates the ROI for these filters will be 11.84%, but I think they are being conservative there and I expect it will be several percentage points higher than that.

Aggressive Prosper Strategy 2: E & HR Loans

I also dedicate a small amount of money to people who are not previous borrowers. I have much stricter criteria here because these are borrowers with no track record on Prosper.

Prosper rating: E, HR
Inquiries: 0
Debt to Income: <=75%
Total credit lines: 16+
Current DQ’s: 0
Previous loans on Prosper: 0
Public record 1 year: None
Credit history: 6+ years
Employment: Employed, Self-employed

According to Lendstats the estimated ROI of these loans is 24.86%. One word of warning, though, the pool of loans for these filters is very small – just 173 loans issued since July 2009 so the estimated ROI of this strategy could change dramatically. I consider this strategy quite speculative so I only allocate a small amount of funds to this. Which is just as well because there are not many loans on the platform with these criteria.

One final point. I rarely read the loan descriptions. The only time I do this is if, for example, I have ten loans that meet my criteria but only enough cash in the account to reinvest in seven loans. I will then quickly scan the loan descriptions and eliminate three loans arbitrarily. I reinvest funds weekly on Lending Club (it takes me about 15 minutes), on Prosper I have an automated plan so I rarely even look at the loans there.

So, that is how invest today. I am always interested in hearing opinions from others? What criteria do you use and how did you decide on it? Please leave your comments below.

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Matthew Paulson (P2P Lending News)
May. 24, 2011 9:50 am

Thanks for sharing your strategies!

Nico
Nico
May. 24, 2011 11:57 am

In your lendingclub accounts, why do you systematically exclude CA loans? Granted the ROI is not the best, but it’s not bad either…

Dan B
Dan B
May. 24, 2011 3:36 pm

I happen to live right outside of San Francisco & I object strenuously to your “redlining” of California in your loan investments. So what if most of my friends & I spend over 70% of our take home pay on our mortgage or rent. So what if our sales tax is 10.25%. California is a great state & I think it is unpatriotic & should be illegal for you to so brazenly discriminate against us. You know, not everyone lives in one of those flyover states where rent is $395 or $70k gets you a big house. That’s just unAmerican! 🙂

Lou
Lou
May. 25, 2011 7:26 am

I limit the loan purpose to Refinance credit card/debt consolidation, Renewable Energy, Wedding expense, vacation, Car Financing, and Major purchase. All the other purposes have higher default rates.

Good job avoiding “A” loans, The probability of an “A” loan paying off early is very high, so you’ll have your money tied up for several months and you’ll make pennies in interest.

Bilgefisher
May. 25, 2011 2:26 pm

Early payoff is the same reason I have avoided folio. It’s the same principle. Yes, the returns are much higher at the beginning of a loan due to interest. The problem is the default rate gets in the way. The more times you churn your money the more opportunity you have for the dice to turn up snake eyes.
Jason

Dan B
Dan B
May. 25, 2011 6:14 pm

Bilgefisher……….Sorry but the likelihood of having “snake eyes” turning up, as you put it, does not increase with the more times you “churn your money”………….again , as you put it. The percentage remains the same.

Also the likelihood of a loan becoming an “early payoff” or not has no correlation whatsoever to whether they are on FolioFN or not.

@Peter………..Although both options are undesirable, buying a note on Folio at par that ends up paying early in a month or 2…………….is better financially than buying the same note regularly (which by definition is also at par) & then having it pay up early in the same time frame. Why?

Because the note purchased regularly will take anywhere from 1 to 2 weeks to get issued & you make zero interest during that time………………whereas the note on Folio will settle in 1 day (except on weekends) & you will earn interest on it as soon as it settles. So anyway you look at it you’ll make extra interest with the Folio note.

Bilgefisher
May. 26, 2011 7:49 am

@Dan Your 100% correct. It does not increase your likelihood. A payoff or selling on folio equates to the same return.

The more often you churn a loan the more often you roll that dice. Assume I have an average default of 4% (pitifully low) and a $100 note at 28%. My first month will give me ~2.46 in interest and 1.72 in principle. I sell or have early payoff after that first month at 98.28. I made 2.46. For every 100 times I do this, I lose $400 (4*100) and make (96*2.46) 236.16 in returns. Now add in my principle return of (96*1.72) 165.12 for a total of 401.28, I have made $1.28 dollars. Not worth the effort, especially if my default is higher. I suggest folks are likely to lose money in the long run through churning.

I’m very interested in others takes on this.

Jason

Dan B
Dan B
May. 26, 2011 4:59 pm

Bilgefisher…………Clearly “flipping” of notes after only a month doesn’t make any sense. But it doesn’t make sense regardless of whether you do it once or a hundred times.

Moe
Moe
May. 26, 2011 7:08 pm

That’s one of the differences between Prosper and LC as LC charges 1% fee of payments whereas Prosper charges 1% a year. So with LC if someone pays off early you will still pay a fee on the whole amount.

Bilgefisher
May. 27, 2011 10:18 am

. Your right. It is the same. The way I look at it though, you needless roll the dice more often when you have to reinvest that $100 that was just paid off. The time factor is very high importance to me. I want this to be a semi passive investment. Let’s assume someone has an automated program to do it for them and time was not an issue. That’s where I ran the numbers. I propose that even if they had an automated program, they will lose money by buying and reselling on folio.

@Dan, I couldn’t agree more.

Dan B
Dan B
May. 27, 2011 6:00 pm

Moe is absolutely right. To expand on Moe’s point we can look at a simple example of a 36 month $25 note at LC that makes 1 regular payment, then pays it all back on the 2nd payment. Depending of course on the interest rate this note will earn the lender anywhere from around 0.6 penny to 1.6 pennnys per day in interest………………or roughly between 18-48 cents per month. The lower number of this range consists of A notes, the highest number the G notes. In the above example the lender of an A note will get 18 cents interest in the first month & pay a penny in fees. In the 2nd month the lender will receive another 18 cents in interest but if the borrower pays it all back the lender will be charged 25 cents in fees. Therefore the lender has now netted 34 cents in interest, but paid 26 cents in fees. So in this example of a early pay after 2 months the lender makes 8 cents on the $25 A note. With a G note the lender would have made 70 cents (48×2=96 cents interest, then subtract 26 cents in fees=70 cents)

However if the borrower were to get the above A or B Lending Club loan & for whatever reason pay it all back on the first scheduled payment 30+ days later……….then the lender in the above example would have actually received 18 cents in interest & paid 26 cents in fees & would have therefore LOST money on that loan. Obviously the above scenario happens very very rarely……………..but it does happen. I’ve been with Lending Club for 19 months now & I’ve had 64 notes pay early, including 1 that paid off after 1 month.

Dan B
Dan B
May. 27, 2011 6:00 pm

Incidentally I’ve complained about this exact thing to LC over a year ago.

Mikael Rapaport
Jun. 21, 2011 2:08 pm

Interesting strategies. The thing that I would absolutely omit when investing in LC and Prosper is the Employment data as they are most likely not accurate and/or not verified by LC and Prosper.

Peerform is using a more conservative approach and is checking every single borrower’s employment by checking IRS records and proof of employment.

Another thing that should be implemented in those strategies is the “correlation” between Notes. This could be done by looking at zip codes, loan purpose, employer, age etc…

Also could be done by looking at the social media profiles of each borrower… so many new things to add to our p2p platforms!

Mikael

Darlene Watson
Jul. 13, 2011 1:17 pm

I am new to Prosper (on the borrowing side), and I’ve tried to use some tips from others when creating my listing. I got off to a pretty good start a couple of days ago, but have now been sitting at 18% funded. I know this site is primarily for investors, but I was hoping to get some advice on how to get a loan funded or on what I could improve on in my lisiting. I am a high risk borrower, but that’s mainly due to lack of credit activity, in my opinion. I’m not super computer savvy, and I’m likewise not great at interpreting what all the stats, ratings, etc. on the site mean to lenders. Any insight would be a HUGE help! Thanks 🙂

https://www.prosper.com/invest/listing.aspx?listingID=515891

Darlene Watson
Jul. 14, 2011 9:02 am

Thanks, Peter. I appreciate your honesty. I probably should have just used my husband in the first place, but really wanted to help my daughter out on my own. I honestly had no idea what my credit was like before creating the listing. I was a stay at home mom for years and didn’t even attempt to get a job or anything (credit related) on my own until my kids were out of the house. I had no idea this would hurt me! Unfortunately, we’re at crunch time now, so it’s just a wing and a prayer that someone believes in me enough to invest! LOL. Thanks again for your insight!