How to Get a Better Return on Your Peer to Peer Loans

This video assumes that you have an account at Lending Club. If you do not please, click on the link below and open up your account.

This is video 6 of a 6 video p2p Lending Series.  Click here for the other free videos.

Open a Peer 2 Peer Lending Account and get started with as little as $25

Open a Peer 2 Peer Lending Account and get started with as little as $25

In a previous video, we discussed that the interest rate that peer-to-peer loans pay  is very different than the expected return, because of loan defaults. Most investors provided that they are diversified among at least 40 loans can expect a return in the 5 to 9% range. However can you do better than the average investor?

Yes. Just like you its possible do better than the average stock market investor with great research, its possible to do better than the average investor in P2P loans. How much extra return is possible? Longtime peer-to-peer investor Ken, the man behind the site Lend Stats, reported earning 16% return over several years.

 

There are three basic ways that you can get an average rate of return that is higher than most investors.

1) Loan Money For Longer Periods
2) Investing In The Higher Credit Risk Loans
3) Find Loans Where The Risk of Non-Payment Is Mispriced

 

Method One: Loan Money For Longer Times

Invest In 60 Months (5 year) Loans Instead of 36 Month (3 Year) Loans

Historically, 60 month peer loans have an average return that are over 2% higher than the 36 month loans. The difference in returns is primarily due to the interest rates charged on these loans. For example, a borrower with an ‘A5” Credit rating would be charged 8.9% for borrowing for the shorter period and 14% for the longer one. Lending Club has set-up rates to reward lenders for for committing their money for longer times.

This is a good strategy and should give you superior returns provided interest don’t rise by more than 4% over during the 5 years of the loan.

 

Method Two: Investing In Higher Risk Loans

The Historical Rate of Return For Loans With Rating D, E, F, G ratings are higher than A, B, C.

Lending Club Rating Return Loans Issued Between 2010 – 2012

A1 – A5 5.0%
B1 – B5 7.0%
C1 – C5 7.3%

D1 – D5 8.2%
E1 – E5 9.0%
F1 – F5 8.8%
G1 – G5 9.0%

The returns of a peer-to-peer loan are composed of two parts. The interest rate which is set for the life of the loan and losses due to non-payment loans. The losses due to  non-payment can vary greatly and can be heavily impacted by the overall economy. Since P2P loans are relatively new we don’t have data on how the rate of  non-payments increase during times of economic stress. What we can say that the data suggest that the returns will be better in the riskier loans if the economy does not go into recession.

If you don’t believe a recession is coming in the next few years, investing in D,E, F, and G should provide better returns.

Method Three: Finding Loans Where The Risk Of Mispayment Is Priced

Lending  Club has a model which they use to rate the probability that a loan will default.  However, that model  is not perfect. For example it may put too much weight on the person’s FICO score and too little weight on person’s ability to hold a job.

Lending Club allows you to choose sort and filter notes by a large number of criteria:

  • FICO Score
  • Income
  • Earliest Credit Line (indicator of age)
  • Number Of Open Credit Lines
  • Purpose of Loans


To analyze how these criteria impact impact the performance of loans, you can visit the site Nickel Steamroller.

If you decide to go down this route of finding loans with higher performance characteristics. I would recommend that you focus on finding one or two criteria for your loans. While its possible to find strategies that generate amazing returns, finding loans which match these characteristics might be difficult, making the strategy difficult to implement.

My strategy is to focus on loans that for paying on off credit cards and where the borrower has not had a delinquent bill payment in at least 30 months.

 

What should you do?

Peer-to-Peer are great investment as long as you are DIVERSIFIED.

Don’t know what to do? Most people will earn a great return by simple investing in B, C, D, and E rated loans. As P2P loans is a great investment, the key to good returns is diversification. Just, make sure that you spread your investment among at least 40 and preferable 200 different loans. There are free to tools for this.

If you want to go for even higher returns that are in the 9% – 10% range, then you can focus on investing in 60 month loans or go for the more riskier loans. Remember diversification.

If you want to get  a return above 10%, that is going to require research. Are you prepared to spend a couple hours per month finding the right loans?

This lesson is part of our Free Guide to Investing in Peer to Peer Loans.  To continue to the next lesson go here.

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