As you have probably gathered by now, I am in a committed relationship with Lending Club. We’ve been together for a little over two months now. I give it my money and they give me fantastic interest rates. While it’s only been two months (so I won’t have any defaults yet), I think I’m doing better than average. I’m at a 15.47% Net Annualized Return, which I’m pretty happy with. To top it off I haven’t had any skipped payments, so at the moment (knock on wood), all my loans are performing perfectly. Clearly, my loan selection criteria are working so far.
Borrowers Are Paying Off Loans Too Fast
Since I don’t have any defaults to worry about just yet, there is something else that is affecting my portfolio negatively. I’ve picked a few people who are too responsible. While most people pay off their loans on their scheduled dates, these three people in my portfolio paid off their loans far too quickly. In fact, they paid it almost immediately.
Why Paying Off Loans Early Is Bad
Maybe these people just needed a short-term loan and were willing to pay a few dollars of interest to get it. It doesn’t really matter to me, but it has affected my returns in two significant ways. Let me show you how:
The first way it affects me is that the amount of time the money sits idly in my account is longer. Instead of funding a different loan, I am funding this one. Either way there’s about a week between when I invest in the loan and when the loan officially starts, but with other loans, I’m ok waiting a week with my money tied up because they’ll be paying me interest for the next few years. When people pay back their loans in full within a month, it means that I wasted that extra week and now I’m going to have to start the process over again.
The second way it affects me is a bit easier to understand. Lending Club charges a 1% service fee on each payment from the borrower. On a $25 loan, that amounts to a about 25-32 cents over the life of the loan depending on the interest rate. For loans that are paid off in the first month, the 1% is 25 cents, which means that I’ll only make about 3-4 cents on the entire loan. That’s equivalent to 1.8% annualized in interest. That sucks, my goal is to make 13% or more on these loans!
Each loan essentially costs 25 cents (1% fee of my $25.00 that I invest in each loan) and 1 week of idle money. In most scenarios that extra week is a very small percentage of the whole loan. In these few cases, it’s 20-30% (or more) of the entire loan period.
I was the return for my investment to be as high as possible. But when they pay back quickly, I only make about 3-4 cents, which definitely isn’t worth it!
If you see loans that people promise to pay off early, stay away! These are definitely loans that should be avoided!