I hear this sentiment all the time. People start off conservatively in p2p lending, investing mainly in A-Grade loans and then decide to branch out once they get comfortable. I know, because I was one of those people.
When you first start out the A-grade loans look very tempting. Low default rates (but not zero) should mean a consistent return on your money. Â Sure they only pay 5-8% but that doesn’t seem so bad, particularly these days. New investors often feel that p2p lending is a risky endeavor in itself so they may as well mitigate that risk somewhat by choosing the most creditworthy borrowers.
What are Your P2P Lending Investment Goals?
It all comes down to your goals for your investment. For me I want double-digit investment returns from peer to peer lending. With that in mind all A-grade investments on Lending Club and AA-grade investments on Prosper pay less than this. So if I invest in these loans then I am hurting my chances of hitting my goal of 10% or more.
Now, I admit not everyone is going to have such lofty goals. Some people may be quite happy with a 5-6% return, especially given the current interest rate environment. If that is your goal then I encourage you to include the A-grade loans in your portfolio.
At Lending Club the interest rates for A-grade loans range from a low of 5.42% for A1-rated loans up to 8.49% for A5-rated loans. Even B1-rated loans are below 10% (at 9.99%). Keep in mind that Lending Club takes out an investor fee of 1% and you can see why it is impossible to earn double-digit returns here.
Prosper is a little different. Their top rating on loans is AA and these AA-rated loans pay in the single digits (although a five year AA-rated loan from a new borrower is currently 10.99% for investors). Single A-rated loans on Prosper can pay as much as 13.9%. So here it is really the AA-rated loans that are not worth considering if you are trying to earn a double digit return.
I am interested to hear from others. Did you start out investing in A-grade loans? If so, do you still invest in them? Please leave your thoughts in the comments below.
I do occasionally invest in “high-quality” loans like these. I’m aware that this will probably decrease my overall return slightly, however it does allow me a bit more diversification across multiple classes of people, which could reduce my risk if something happens which causes sudden losses across a large class of people. In addition, I feel like the kinds of people who are asking for these loans are more likely to be using the money for some economy-stimulating purpose (like home improvements) than just refinancing other debts, so it makes me feel good to buy the notes.
@Tyrel, I can see why you have made those choices. If the economy tanks it will be interesting to see whether the default rates increase more in the lower grades than the higher grade loans. I would expect A-rated loans would have less of an impact but there is no way to know for sure.
Sure I bought some A notes early on at Lending Club……………but rarely do so nowadays. Once in a while I’ll pick up an A5, but only because there isn’t much else that’s attractive. That may seem like a silly comment but if you’re deploying money as soon as it becomes available &/or on a recurring monthly basis, availability of interesting notes can still be an issue.
A5 is the highest quality loan I will invest in.
D5 is the lowest quality loan I will invest in.
The largest portion of my portfolio is B rated loans at ~50%
C=25%
A5=12.5%
D=12.5%
As Dan mentions the A5 are included main because its better to invest the cash fast then have it sit waiting for that somewhat rare C-D rated loan that meets my requirements.
One other reason not to invest in A rated loans, they pay off early, sometimes so early that you lose money. Lending Club’s 1% fee means you need to earn 25 cents in interest (on a $25 loan) to get your principal back. Granted it’s not a lot, but when you factor in the time your money was locked in waiting for the loan to close (up to 13 days), the loan getting paid off early (may or may not make any money in interest), then redeploying that money on a new loan (waiting 13 days for that one to close), wash, rinse, repeat…It kills your returns. I want my money to go to work and stay at work.
Lou
@Dan/@Charlie, Even with 800+ notes on the Lending Club platform most days it can still be challenging to find good notes if you have pretty strict criteria which it sounds like you do. Personally, I would rather leave the cash in the account and wait before going with a lower interest note, but it is a personal choice.
@Lou, That early payment problem is certainly an issue that Lending Club needs to fix. An investor should NEVER lose money just because someone has happened to paid off their loan early. They have made a great deal on the loan origination, I would like to see them refund the 1% fee on all loans that pay off in less than three months. I will continue to talk with them about this.
I would second that Peter…………..or at the very least refund the fees on loans that pay off on the first loan payment. This isn’t an issue that has come up much for me personally but it has happened a few times nonetheless.
And incidentally………..in addition to funding time & in review time. you can add “issuing date” to the mix. It’s not uncommon for a loan to have an issuing date 5-7 days after it’s been funded & approved. So you can easily have a lag time of 20-23 days from the time you invested to the time the loan was issued (12+ days funding+ 3-4 days in review+ 5-7 days to issue) This is not uncommon & during this time our money earns no interest.
In the interests of being fair & balanced let me provide this addendum to my previous post.
In the 21+ months I’ve been with Lending Club I’ve had a total of 82 notes pay off early. I don’t have any breakdown as to how early, but like I said previously, a few have paid off with the first payment. Obviously that scenario is not indicative of the norm. I’ve invested $2054 into these notes & received $2194 back. So overall & despite the early & sometimes very early payback, principal clearly isn’t being lost. Nevertheless I stand by my previous comments & agree with Peter wholeheartedly on this issue.
PS……….Before anyone questions the math, I have no idea why $2054 doesn’t divide neatly into 82. But I did notice it.
@Dan, You make a good point about the time lag between investing in a loan and when it issues. Of course, you have to add to that at least another 30 days before you will see any payments back in your account. This is why I know several investors who will only invest in a loan that is 70% funded or a loan that only has a couple of days left to fund. You can reduce the amount of time this way but the downside is that it leaves even fewer loan choices available.
Well you know unless you’re actually investing in other loans instead, it doesn’t really make a difference whether you invest early or late in the funding cycle.. Since cash pays no interest in p2p, it doesn’t matter whether your funds sit in cash balance or in funding. I completely understand funding time but I wish that they’d eliminate the lag time from funded to “approved” & the lag time between approved & “issued”. That’s all.
Peter,
Have you mentioned creating a standard pre-payment penalty for paying off the note before a certain amount of time passes? I get the sense that this would be a more attractive option to Lending Club.
I started out by investing in ALL grades (huge diversification), but as of April 1st, I only invest in notes that has a yield 0f at least 17.99% (C-HRs).
I also began selling all my AA-B notes in the secondary market with a 1% discount, with some success. Still have about 30 AA-B notes that I need to unload.
I think as long as lenders pay more attention to their ROI, instead of worrying about a note defaulting, I will definitely increase my ROI moving forward.
@Dan, Agreed. I understand taking a day or to issue a loan but 7 days makes no sense to me.
@Kyle, Lending Club makes a big deal about no pre-payment penalty in their marketing to borrowers. So, while I love this idea I don’t think it will get any traction. But I will certainly keep it in mind when I chat with them about this.
@CA-Lender, I am with you except I only consider loans that are at least 20% which is basically D-HR’s. I am also in the process of trying to offload some A notes. But I am trying to break even on them (at a 1% premium). Not much luck so far.
I started out investing mainly in AA – B on prosper. As I’ve done more research, and I’ve become more comfortable taking on a greater risk, I have diversified into the lower grade notes. I have no intention of going the route of never purchasing notes above a certain grade as I would prefer to keep my investments more diversified. I prefer lower risk, and I accept the lower rewards that come with it. Yes, the 20%+ rates are very appealing, but life happens. I would rather pursue a portfolio with a broader exposure (and lower return) that can (hopefully) withstand acts of God (better than a portfolio that is less diversified in the pursuit of a higher return).
@Peter:
I’ve tried selling AA-B with a small premium (1-2%), but unless they are very well aged (>12 mo), no one will buy them. Even with a 1% discount (2% total cost), they don’t sell all that fast.
There is always a “mental block” of selling investment at a “loss”, but I think overall, by taking a 2% loss on notes return that 8% or 9%, and reinvesting in notes that have a net ROI of over 12%, it’s worth the loss upfront.
@Roy, Thanks for chiming in. I agree that if you go for the higher interest notes you have to be prepared for defaults to be above normal – it is certainly a riskier investment particularly if the economy goes south.
@CA-Lender, Thanks for the tips. I haven’t given up yet, but it looks like I may have to go down the same route and a lose a little money on these notes. I have sold notes at a loss before but always try to ta least break even when first putting them on the market.
As a borrower, I noticed that Lending Club and Prosper seem to use radically different rating systems. I applied for a loan on Lending Club and was assigned an F2 rating and a corresponding interest rate above 20%. I assumed this was mostly because of a TU score on the lower end of the acceptable scale (albeit above LC’s minimum of 660), though I noticed D listings with similar credit scores. My income is pretty high (as P2P borrowers go), my DTI percentage (as calculated by LC) was under 6%, I had no recent inquiries and no delinquencies in the last 2 years. I quickly developed second thoughts about the the interest rate, cancelled the listing and checked out Prosper. Prosper gave my listing an A rating and an interest rate of 13.9%, even though I had a bunch of delinquencies 5 or 6 years ago during a rough patch, and Prosper, unlike LC, includes the number of 90-day-plus delinquencies going back 7 years in its listing info. Noting had changed in the brief interim between applications, and I provided all the same info. The loan funded and closed within a week. Of course, I’m coming at this from the perspective of a borrower, and I’m happy for the interest savings. But if I were a lender (and I’m now thinking about becoming one), I would have to wonder about the sharp disparity between credit grading on the two platforms. I know that Prosper uses Experian while Lending Club uses Trans Union, but last I checked my scores with the two bureaus weren’t radically different (i.e., they were within 25 points of each other).
@BigIslander, Thanks for sharing this. Both Prosper and Lending Club have different scoring models for determining interest rates which is highlighted by your experience. Lending Club actually makes there interest rate calculations public here:
http://www.lendingclub.com/public/how-we-set-interest-rates.action
You could have become an F grade loan due to a number of factors such as high number of credit inquiries in the last six months, revolving credit utilization over 85%, total number of open credit accounts over 21 or a credit history length of less than 5 years.
Prosper relies more on its own scoring method, comparing all your credit information to other borrowers on the platform. If other borrowers performed well then you get a lower interest rate.
Glad you were able to get your loan funded at a good interest rate.
Thanks much for the info, Peter. In reviewing LC’s scoring model at the link you provided, it seems I went down all the way from a C1 to F2 based on the amount of my loan request and the fact that it was for a 5-year term (I did change the term to 3 years when I applied on Prosper). This is good info to have before one applies, and it’s right there on LC’s web site so it’s my fault I didn’t have it. By the way, your web site is a great resource. It is by far the best place to learn all about P2P lending.
@BigIslander, You are not the first person to not see that. I wish they would make it a prominent part of the application process so you can see that a 5-year term and a high dollar amount hurt your interest rate. I might even do a blog post myself to highlight this for borrowers. And thanks for your kind words.
BigIslander………….I would also like to thank you for sharing your experiences in obtaining a loan. We don’t often get information from borrowers who have applied at both outfits back to back.
Peter – When I first enrolled with LC, I actually allowed them to pick my loans with their automated matching technology. BIG MISTAKE! I then switched to manual selection limiting myself to A & B grade loans. SECOND MISTAKE! After becoming disenchanted with my returns when compared to others (I’ll save that for your other blog post), I stumbled across your blog and read many interesting posts/theories about selecting more risky notes. My returns are starting to trend towards the 5-6% territory however I have several defaults I’m afraid I will have to work my way through.
Thanks for your blog and please keep posting!
@Mark, When you already have a substantial sum invested and you realize you have made some mistakes it can be a bit like turning an aircraft carrier around. By investing in higher return notes you can move your returns up little by little but it can take a long time before you can see much of a difference. Thanks for joining the conversation.
I make a very good salary in the triple digits, have paid off 6 credit cards last year and have a 720 credit score, but I got an F2 rating on LC. Don’t really get it.
@Steph, I am guessing you wanted a five year loan for more than $25K. That will automatically move you down several loan grades. Take a look at this post which will give you more information:
http://www.sociallending.net/borrowing-2/how-lending-club-and-prosper-set-interest-rates/
I was rather pleased to find my loan request thru lending club to be rated A5,sorry to all that find this unattractive? If my plans for this capital come to fruition,I’ll be able to clear this note in a few months……………..but I won’t,because everyone that had the faith to invest in me will see a full return đŸ™‚
Jim, There are many investors who like to invest in A-grade loans, I am just not one of them. It is nothing against you or any of your fellow borrowers it is just where I am most comfortable investing my money. Best of luck to you.
It’s sad from a borrowers poerspective that those with the highest credit are essentially penalized in the form of lower invester interest in their loans. Thank goodness LC itselfs funds some loans.
That is not completely true. Many investors only like to invest in the low risk, low interest rate loans. But the problem is that there are so many of them. Over half the loans at Lending Club are Grade A and Grade B which means more competition for investor dollars.