Being average is not that impressive. To be better than average is always an admirable goal, and as a Lending Club borrower, there are some easy steps we can take to get the high returns we’re looking for.
The average default rate on lending club loans varies by grade (A-G, As have low interest rates but low default rates while Gs have 20%+ interest rates along with higher default rates). Lending Club boasts an annualized default rate of less than 3% across all loans.
Defaults reduce your returns significantly, so a large part of selecting loans is trying to determine which loans are least likely to default. While high interest loans are great, if a loan defaults, you probably only get back a fraction of the amount of money that you originally lent. If you spread this logic across all loans, you’ll see why reducing the default rate in your portfolio is so important.
For example, the average interest rate for E-rated loans is 17.36%, while the default rate is about 7.3% over the life of a loan. Defaults don’t mean you receive no money at all, just that after a certain period of time, the borrower stops making payments. Therefore, the average person who invests only in E-rated loans can expect to receive a return of 11.88%.
The goal is to select notes that I think have a lower than average chance of defaulting. That way, the loans would achieve a higher than average interest rate, and when you’re talking about higher than an 11.88% average, you’re doing pretty well.
By simply weeding out the lower quality loans, I’m trying to leave myself with the high quality stuff and a superior return. I decided to try lending club with a Roth IRA recently, and I am aiming to return greater than 13%, which is fantastic when compared the the stock market and especially to other investments during this recession.
If I see loans that has warning signs (we’ll get into that in next week’s post, but one example is a borrower who says they’re “hoping” that they will be able to pay back on time each month), I stay away. I try and predict whether that person will be likely to default and if I see anything that makes me think they are more likely to not be able to make payments, then I will pass and move on to what I believe are more worthy borrowers.
However, I think that it is a very reasonable goal because it’s based on past lending performance (which should be much less volatile overall than the stock market), and the statistics back up my theories. Only time will tell how well I do, but several other bloggers have achieved 13%+ returns and my brother, who has been investing for awhile now, has seen great results and even a few defaults wouldn’t lower his existing returns too much.
Next week, I’ll go into detail on how I select my loans and what criteria I use to weed out the low quality loans. We’ll be tracking my progress each month, so we’ll get a feel for how this strategy works, what trends I see, any advice I have going forward.