Lending Club Loan Selection Criteria

As you know, I’ve been focusing on Lending Club a lot recently, mostly because I recently moved to California and am now eligible to start lending!

Well, I opened a Roth IRA with Lending Club and funded it with $5,000. Each weekday, I go and search for a few loans that I like.

I invest $25 in each note, which means 200 notes for me to be fully invested. I could have chosen the auto-invest option or used Lending Club PRIME, their concierge service, but I wanted more control over my lending. At the beginning, I was looking for anything with a decent interest rate that didn’t stick out as especially risky. I avoided people who didn’t make much money and who in the answers section admitted to declaring bankruptcy. But I didn’t have a strict set of rules. Slowly I developed a set of criteria which I now stick to.

I try and select the higher quality loans that will help me achieve a greater than 13% interest rate. I try and minimize my default rate while looking for high quality loans. Here’s how I do it:

Nickel Steamroller offers a return forecasting tool that allows us to test various loan conditions. The aim is to find, based on past performance, high quality loans for the future.

Not every loan conforms to averages, but over hundreds of loans, we can minimize our risk by investing in higher quality loans. Remember, the goal isn’t to pick only the best loans out there, it’s to be a little better than average with our loan picking and to minimize our default rate. This tool allows us to do exactly that.

For example, we see that for C-rated loans, the average default rate is 4.65%. When we set just one filter, than employment length of the borrower must be 5 years or more, the average default rate drops to 4.03%. That’s great! We want to filter out those who are likely to default and get the cream of the crop. And if we filter for only those who have been employed for more than 10 years, the default rate drops all the way down to 3.76%! Clearly longer employment is good for us!

It’s not always easy to find many loans with high interest rates for people who’ve been employed for 10+ years, so for now lets stick with 5+ years of employment to give us more flexibility.

Next, I like to filter out people who have had recent inquiries. I set ‘inquiries in the last 6 months’ to ‘0’ and refresh results. And the default rate goes down to 3.50%. Great!

With just a few clicks, I’ve been able to reduce the average default rate from 4.65% to 3.50%. I’ve reduced my average risk quite a bit and feel more confident.

I also like investing in loans to people who own their homes or have mortgages as this also drives down the expected default rate. Finally, I filter for people making over $4,000 per month. It drives the default rate down slightly and at a lower income, any unexpected expense could mean bad things for my loan.

Filtering in this way is a great way to avoid risky loans without even looking into the loans in much details. I also like to read the descriptions and answers for clues as to what type of borrower they are. So filtering is not the only thing I do before selecting loans. There are lots of warning signs I look for before investing money in these people.

Next week, I’ll go over what to look for when investigating a loan in more detail, and if you’re posting a loan as a lender, things to avoid! Remember, if I invest in 4 loans a week (at $25 each), I have to narrow it down even more!

7 Responses to Lending Club Loan Selection Criteria

  1. I would love to do all of that stuff.

    Stupid Texas

  2. I think the P2P lending is so interesting. I’ve never looked into it myself but I’ve thought about it. I like the idea of investing a large amount, but then only lending $25 to each person. I thought you had to loan larger sums.

  3. Daniel, Good explanation of the filtering process. I think it is crucial that investors in p2p lending do some kind of analysis like this otherwise you are just going with your gut. It is far better to have the hard numbers behind you.

    The only thing I would add is you need to make sure when filtering down the loan pool you leave enough loans to give a statistically valid result. I always like to make sure there are at least 500 loans in the loan history before making any kind of assumptions as to whether my criteria is helpful.

    • Daniel says:

      @Peter Renton, Good point, I saw a lot of loans in the tool based on those criteria (weren’t THAT limiting), the tricky part is filtering too much that you find only a few active lending club loans with that criteria!

      • Simon Cunningham says:

        @Daniel, Just to add to what Peter said. For larger amounts to invest, like if you are investing $5000, a filter that returns more historical loans is usually going to mean it has more current availability.

        You could always use a filter that has 2000 or 3000 historical loans if you want to find loans quicker (although this may mean a slightly lower ROI).
        Hope that helps.

  4. Great explanation on the filter. I just started with Prosper.com and will need to figure out how to filter there.

  5. Squeezer @Personal Finance Success says:

    I have several loan selection criteria. I do not fund vacations or weddings as I consider these to be frivolous expenses. I also do not fund home improvement projects. A house could be foreclosed, and that is too large of a risk at the moment.

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