Let’s face it. Treasurys, checking accounts, CDs and money market funds are offering some pretty darn unattractive yields for investors today.
Even if the Fed raises rates a couple times in the coming year – which is very doubtful – they won’t come close to the rates we’ve seen in the past.
Take a good look at this historic chart of the U.S. federal funds rate.
The current rate is about 0.25%. One quarter of one percent… ridiculous!
Worse still, banks aren’t even trying to keep up with the Fed rate.
According to RateWatch, current national money market and savings rates average just 0.11% for accounts with $10,000 or less.
It’s a sad situation… But that doesn’t mean your portfolio needs to settle for less.
If you’re truly tired of wimpy interest rates, you’ll be happy to hear about a new disruptive force in the online lending market.
It’s called peer-to-peer lending, and it’s your key to pocketing interest from loans that, up until now, banks and commercial lenders have only been privy to.
Peer-to-peer lending, also known as P2P, or social lending, takes place on socially connected websites. It connects consumers and businesses looking to borrow money at below-average interest rates with real people who are willing to lend that money. No bank is required.
Most borrowers come to these sites for a range of reasons, including consolidating credit card debt, paying medical bills, remodeling homes, handling educational expenses, taking out business loans and even paying for events such as weddings.
Some websites just function as middlemen, but many do a great job of sifting through potential borrowers to identify quality and help manage default risk.
Loans normally consist of bundles of money provided by a number of lenders. This allows lenders – or what many sites call investors – to pool money together and spread their risk across many loans.
Individual borrowers can ask for anywhere from $50 to $35,000, while business loans can go as high as $300,000. Though those numbers are growing.
As a result, peer-to-peer lending has taken off since it offers more transparent, efficient and consumer-friendly borrowing and lending.
P2P sites operate at lower costs than traditional banks, which allows them to offer loans at lower rates as well as provide investors with solid returns. Borrowers typically pay interest rates ranging from about 5% all the way up to 35%, depending on their risk status.
And with P2P lending, you can kiss the standard bank application process goodbye. These sites can turn around loan requests and approvals in mere days.
As you can imagine, things have really started to take off for P2P operators. Over the last few years, countless sites have started to gain traction and bring in impressive revenue.
Prosper is one such company. Founded in 2006, it already has more than 2 million members and $8 billion in funded loans.
Two similar businesses would be Upstart and Zopa.
Then you have Funding Circle, a site that serves small businesses that most likely couldn’t get through the standard bank’s red tape loan gauntlet.
Founded in 2010, Funding Circle started in the U.K. but has since expanded into the U.S, Germany, Spain and the Netherlands. It has lent more than $12 billion to small business owners since it began.
There are even nonprofit sites like Kiva that allow lenders from well-off nations to loan money to low-income entrepreneurs and students in the developing world. Since its founding in 2005, Kiva has attracted 1.9 million lenders and more than $1.4 billion in loans, boasting a stellar repayment rate of 96.4%.
Or, for those who don’t care about who they’re lending to – and who are willing to pay for the convenience of having someone else evaluate the loans, there are platforms like NSR Invest.
These companies typically charge 0.6 basis points to manage your portfolio for you, and they select loans based on your risk parameters. For example, NSR’s historical returns range from 7.2% for its conservative strategy to 10.7% for its most aggressive one.
And you can start with any amount of money, though NSR suggests $10,000 in order to have a well-diversified portfolio.
The Big Kahuna of Online P2P Lenders
Of all the online lending sites out there though, the undisputed industry leader is LendingClub (NYSE: LC). It’s also one of the few online lenders that have gone public.
In December 2014, the company listed on the New York Stock Exchange. The San Francisco-based company raised almost $900 million from its IPO, offering more than 57 million shares at a price of $15 each.
That isn’t small peas. In fact, if it wasn’t for Alibaba’s (NYSE: BABA) blockbuster offering that September, LendingClub would have been the breakout tech IPO of the year.
As it was, it was still one of the 10 biggest tech IPOs in history. So it’s not surprising that Alphabet (Nasdaq: GOOG) saw its potential and invested in LendingClub’s pre-IPO.
But let’s dig deeper into this industry leader so we can see why it’s the top dog and get a better picture of how lenders (aka investors) profit from its loan platform.
Founded in 2007, LendingClub is the largest P2P lending platform in the U.S. It’s arranged close to $29 billion in loans since inception. The reason so many investors like LendingClub’s platform more than others is its strict screening process for borrowers. The average borrower has:
- A 699 FICO score
- A 16.9% debt-to-income ratio (excluding mortgages)
- 15.8 years’ worth of provided credit history
- $73,157 in personal income (i.e., they’re in the top 10% of U.S. earners).
LendingClub’s average loan size is around $14,000. But as I already mentioned, P2P sites like LendingClub pool investor capital and spread the risk around.
So with LendingClub, you can invest in fractions of loans in $25 increments. Each fraction loan, called a note, comes in a 36- or 60-month term depending on the corresponding loan.
These notes then allow investors to diversify their portfolios and reduce the impact of any single loss.
For example, a $2,500 investment could be spread across 100 notes. And 100 is the magic number to aim for, since 99.9% of investors who own 100-plus notes of relatively equal size have seen positive results.
Loans are graded according to risk. In the chart below, you’ll notice that each grade has two columns – one that’s gray and the other in color.
The dark columns show the average interest rate for loans of each grade. So grade A loans have a 7.51% average interest rate while grade G loans – the riskiest – come in at 23.98%.
I know those returns look very appetizing, but it’s important to know that those interest rates don’t fully reflect what you’ll actually get as a lender, since some loans go into default.
If that happens, service charges and collection fees can eat into your returns as LendingClub works to get delinquent loans back to current status.
So the gray columns paint a clearer picture of the adjusted returns you should expect. As you can see in that same chart, actual returns on grade A loans average 5.12% a year, grade B loans average 6.98%, grade C average 7.78% and so on.
Clearly, even accounting for default and collection fees, you can get a solid return that blows paltry Treasurys and money market funds out of the water. And best of all, you get monthly interest payments you can pocket or reinvest into other loans as you see fit.
Think about what that kind of rate of return can do for regular investors.
Let’s take a look at $10,000 invested in grade A loans at an average rate of 5.12% versus $10,000 in various Treasury bonds at current rates.
In just five years, your loan investment would become $12,836… compared to $10,757 with a five-year Treasury bond.
In 10 years, it would have amounted to $16,476 – compared to $12,590 with a 10-year Treasury.
And in 20? You’d have $27,146, an astounding 60.6% greater return than the $16,905 you’d have made in a 20-year Treasury.
Moreover, those are just the grade A loans. With grade B, which is still fairly low-risk, those returns are much greater.
In that case, you’d be looking at $14,012 in five years, $19,635 in 10… and $38,552 after 20: a whopping 128% higher than the $16,905 you’d have gotten from Treasurys.
If you’re interested in becoming a lender (or investor), LendingClub could be a good place to start. Just make sure you check out its detailed information on service and collector fees at www.lendingclub.com.
The New Age of Online Lending Is Here
A fresh ecosystem of startup companies is changing the way money flows in the financial markets.
Financial disrupters like LendingClub – and countless other companies – are advancing peer-to-peer lending technologies to effectively compete in the loan business that brick-and-mortar banks have dominated for centuries.
Now individuals like you have the opportunity to profit like the big banks.
Naturally, there are risks involved in lending money to borrowers. But as you’ve just seen, even the most conservative loans offer attractive interest rates compared to what’s out there in today’s market.
Online lending offers a serious avenue for investors to seek out better returns for their portfolios. You’ll simply need to do your homework to determine which platform is your best match.