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!