The Financial Fitness Club

Where you go to get your wallet in shape. 

Lending Club

Written by: FFC Trainer James
February 15th, 2008

With an unreliable stock market and a Federal Reserve lowering interest rates every quarter, where should you be putting your money to get it to work the hardest for you? Maybe it is time to think outside the box with an alternative investment vehicle.

Here at the FFC, we do not give specific investment advice, so you will never hear us give out a "great stock tip". However, we do feel it is important to look at all the types of investment options you have available to you. Today, I want to talk to you about one you may not have ever heard of.

The housing market and specifically the subprime credit crunch have weighed heavy on the stock market. With recession fears in the air, the historic average return of the stock market of 8% seems unlikely for the near future. The same factors have led the Federal Reserve to lower interest rates. This leads to lower returns on interest checking and savings accounts, money market accounts, and even CDs. With the traditional places to put your money to work not looking as attractive as they have in the past, I want to look at one non-traditional option.

Many of you have heard or seen the phrase "Peer to Peer" or P2P. Arguably, the most famous P2P service was the original Napster, where millions of people connected to each other across to the world to share music. This was later deemed to be illegal, but the P2P concept is still around today. One such implementation of this is Peer to Peer lending, or social lending.

Let me explain what a P2P lending site is and how it works. The basic idea is that some people need to borrow money and are willing to pay interest to get that money and some people have money and would like to earn interest on that money. Today, most of the time these people use banks to accomplish this. The bank pays someone a small interest rate, and then lends that money out to someone else at a higher interest rate. The benefit of P2P lending is that you cut out the middle man and the profit that normally goes to them. So, the borrower gets a loan at a better (lower) interest rate and the lender earns a better (higher) interest rate.

So what makes social lending a better investment than the stock market or CDs? Well, the easy answer is that you can earn a much higher interest rate. Without the bank in the picture to take its cut, your money can work harder for you. But I think there is an even better answer. Even though we here at the FFC talk a lot about money, our ultimate goal is to improve your quality of life. And social lending presents a wonderful opportunity to help improve the quality of life of people. You get to directly help someone (most of the time total strangers). You might be helping them get rid of credit card debt, or buy their son his first car, or pay for the surgery their mother is in desperate need for. The point is that your money is not only working for you, but now it is working for someone else too. I know what you are thinking, "This sounds great, but aren't there risks?"

Like any investment, there are risks that must be considered. My father once gave me a great piece of advise. He said, "Never lend money to a friend unless you are OK with losing that friend and your money". He wasn't implying that my friends would welch on a loan, but things happen that are out of our control. So, when I first heard about social lending you can imagine my specticism. Lending to strangers sounds even more dangerous than lending to friends, so we need to take a hard look at the risks. Any time you invest money, the fear is that you will not get your money back. When dealing with lending money to people, there are two main factors that we need to look at. These two things are the trustworthyness of the borrower and the incentive to pay back the loan. If someone is not trustworthy, then they might take your money and never pay you back. So, you better make sure you are lending to the right person. Secondly, if there is no incentive to pay the loan back, then the borrower might not feel any need to pay back the loan.

There are a number of social lending sites out there, but we wanted to find one that mitigated these risks as well as possible. Lending Club is a company that we believe handles these risks very well. To start with, a minimum FICO score of 640 is required of every borrower. This is to help establish the trustworthyness of the borrower. But in addition to this, the lender can review each borrower to see a wide range of data to determine if they meet your criteria for being trustworthy. Some of the information that is available includes the borrower's home ownership status, current job title, employer, tenure at job, gross income, debt-to-income(DTI) ratio, open credit lines, credit balance, percent of credit balance used, number of delinquent accounts, delinquent amounts, delinquencies in the last 2 years, and months since last delinquency. All of this information can be used for the lender to decide if they trust the borrow to pay back the loan. But the Lending Club also understands the importance of encouraging the borrower to pay back the loan. The best incentive that Lending Club uses is laziness. A borrower will have their monthly payment automatically debited from their checking account. So, it is actually easier for the borrower to make their payments, then it is to not make the payment. On top of that, Lending Club enforces late fees and will even report late payments and delinquencies to credit agencies. In the event of a delinquent account, they will assign a collection agency to recover the lost funds. Because each person has a different situation, Lending Club has created a rating system to assist in the assessment of a borrower. And the interest rate you earn is actually tied to this rating system. This ensures that the greater risk you take, the greater reward you get. This is a very important aspect of any investment.

As a special promotion for our FFC readers, if you decide that you want to try the Lending Club, you can sign up under the link below to get your first $25 in your account just for signing-up. And as an added bonus, if you make an initial deposit of $1000 or more, Lending Club will give you an additional $25. That's $50 for $1000 investment. That is an instant 5% return!
Click Here to recieve $25 just for signing up

As always, you should do your own research before investing in anything. This article's purpose was to get you to think outside the box and realize there are other options available to an investor besides the stock market and CDs.