Whenever you make an investment in either Lending Club or Prosper you are presented with an estimate of your return for that particular investment. But what does that really mean?
The Expected Default Rate at Lending Club
Let’s take a look at this graphic from Lending Club to explain how they calculate projected return. In this particular case I have chosen to invest in one 36-month loan that is rated B4 with an interest rate of 12.99%.
This expected default rate of 4.15% in this example is the expected percentage of principal loss for the entire population of 3-year B4-grade issued by Lending Club today. It is based on Lending Club’s proprietary algorithm and is different for every interest rate. They have built this expectation based on their own experience of their historical loans. They adjust this number from time to time, in fact, just recently (in June) they made a significant adjustment to the expected default rate for every loan grade.
The Mistake Many New Investors Make
The projected return number of 8.14% isn’t the return I will receive for this one investment as some new investors think. This is the expected return I would receive if I invested in a large basket of loans exactly like this one – as in 36-month, B4 loans at 12.99%.