Monthly Income

Another very important indicator of a debtor’s ability to pay his dues is his income. This may sound obvious, but the entire purpose of a credit score is to determine the ability of a person to pay debt (their creditworthiness), and still the credit score (FICO etc.) doesn’t consider the income of an individual or household. This is simply because the income is not an information that you can find in a credit report.

For you as a creditor, having the chance to analyze the income of the borrower is a very powerful feature. But you have to be careful, as most of the listings in LendingClub are not verified, so the stated monthly salary may be fictional.

Another way of looking at this attribute is what percentage of the income will go to pay the loan installment. Here is a reference matrix, showing how much the installments is based on the term (table 1 is 36 months and table 2 is 60 months) and the loan amount (rows) and interest rate (columns).

36 10% 15% 20% 25%
5000 $161 $173 $186 $199
10000 $323 $347 $372 $398
15000 $484 $520 $557 $596
20000 $645 $693 $743 $795
25000 $807 $867 $929 $994
30000 $968 $1,040 $1,115 $1,193
35000 $1,129 $1,213 $1,301 $1,392
60 10% 15% 20% 25%
5000 $106 $119 $132 $147
10000 $212 $238 $265 $294
15000 $319 $357 $397 $440
20000 $425 $476 $530 $587
25000 $531 $595 $662 $734
30000 $637 $714 $795 $881
35000 $744 $833 $927 $1,027

If the burden of the loan on the borrower’s finances is over 30% of their income, you should start to get worried whether or not they will be able to pay for their daily expenses while at the same time keep up with the debt payments. If that task becomes impossible, it’s mostly certain that the daily expenses will prevail.

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Description Level

The description entered by the borrower to request the loan is probably the most debated subject in P2P lending the internet. You can find endless advice about what to avoid in the text: bad spelling, mismatching information, contradictions with the credit report, lack of explanations, low drive to defend the need for money.

But is this based on facts, or just an attempt to be zealous and diligent but only based in intuition and common sense?

Interest Radar’s Description filter can aid you in answering this question. Here is what each value means:

  • None: when the description entered is blank or the length of the text entered is less than 10 characters
  • Short: when the length of the description is 10 or more characters, but less than 400
  • Full: when the length of the description is 400 or more characters

If you’re used to the Quick Chart by now, you can see how the length of the description affects the loss rate with this:

Loss Histogram

Apparently, too much description is a bad sign. As a matter of fact, loans with no description will perform as well or better than the ones with description.

A word of warning though: LendingClub doesn’t include in its public database of loans the answers to questions by borrowers. Only the initial description, and the additions to the description, are shared in the file.

If you don’t feel comfortable lending to a stranger without first reading their story and making sure it has a strong and consistent explanation for the need of money, you can always review the description clicking on the loan number in the Current Listings list before investing.

Loan Purpose

If the first filter you’ll always set is the credit grade, so that you have a chance of getting high returns, and the second is the loan length, so you can adjust for how long your money will be committed, probably the third most important filter in LendingClub is the Loan Purpose. Few other filters are so significant.

You can quickly notice how different each purpose performs by looking at the Quick Chart (only loans C through G):

Loss Histogram

Again, the black bars represent number of loans while red bars represent the loss rate. You can see that there are many purposes in the chart with a low volume of loans but a very high loss rate. And there is Debt Consolidation, the third pair of bars, with the highest number of loans issued and a somewhat low loss rate. And there are some purposes that have an average loss rate that is even smaller than Debt Consolidation, some of which you may find surprising: Credit Card, Car, House Down Payment, and Wedding.

Interest Radar filters indicate the purposes that have higher risk of default with a red text.

Let’s take a look at some of the purposes and see if we can understand how they behave.

Car, House Down Payment

These are interesting purposes for a LendingClub loan, from a credit perspective. Why would a borrower shop for unsecured-grade interest rates to purchase for an asset that is commonly attached as a collateral for a loan? The only explanation is that the mainstream credit industry is turning the borrower down for some reason. For a house we understand what is going on: after 2009, no bank is risking to be in a junior creditor position with real estate as collateral. And the market is offering normally no more than 80% of the closing price of the house. Some people will need additional funds to finance a house. LendingClub is a good option for them.

Cars are a bit different. It’s still relatively easy to get car financing or leasing if you have good credit, with just a small down payment. And a car is the most important asset for an employed person, so the default rate on secured car loans are the lowest in the industry, much lower than even secured mortgage loans (you can always abandon your property and go rent, but in most places you can’t walk or use public transportation to work). Despite all this, statistically, car loans in Lending Club have a comparatively low risk.

Credit Card, Debt Consolidation

One issue we have to deal with is that the borrower sometimes do a poor job filling out their loan request forms. A classic case is the confusion between Credit Card and Debt Consolidation. It’s not clear for them which one is supposed to be selected in what situation. Therefore, it’s almost pointless to differentiate these two purposes when analyzing performance.

Also, almost 70% of all loans are either Credit Card or Debt Consolidation. That means most of your investment will be in these categories.

Business

Unfortunately, small business loans have a terrible track record in LendingClub. Probably the platform isn’t robust enough to allow venture capitalists to understand the business’ chances of success. Or maybe the loans are being taken as a last resource by entrepreneurs that are already on the verge of bankruptcy. LendingClub doesn’t give us much insight into that, as there is no way for us to understand the situation of a debtor after default: whether they filed for bankruptcy, or they deceased, or they just accumulated much more debt.

Wedding, Renewable Energy

At first sight, these purposes appear to be quite lame for a loan request. But turns out that, when the right filters are applied, they show a pretty nice performance.

State

Interest Radar state filter allows you to select the top 9 states in number of loans. For the sake of being practical (read about our principles if you haven’t yet), the remaining states are grouped together as “Other”. There is not much reason to create a strategy to focus for example on South Carolina listings, when the total number of loans so far to SC was around 800, or less than 14 in average every month. Statistically, their performance can’t be determined.

The difference between states, from a credit standpoint, is not only cultural (think Texas), but mainly related to state law and court inclinations. How easy is it to file bankruptcy, how expensive is it to sue, how fast is it to foreclose.

As is normally the case, the State attribute shouldn’t be used by itself to rule out a group of loans. Let’s do an exercise to compare FL and CA, for loans issued with grades C-G.

If we simply request Interest Radar for the breakdown of the loans in these two states, we will see that CA has the higher loss rate of 5.7% and FL is a little better with 5.6%. But let’s test something now and select only loans with zero or one delinquencies in the last 2 years. Now the picture is inverted: CA is 5.6% and FL is 5.8%. So, we decreased the loss for CA and increased in 0.2% the loss in FL. That means we’re turning down some loans in FL that have 2 or more delinquencies but in average have less than 5.6% loss rate, therefore increasing the average loss rate for that state. In CA the opposite occurred, as it appears that 2 or more delinquencies are a really bad sign there. You can verify this by yourself by filtering out zero and 1 delinquencies, and looking at CA and FL one at a time. Surprisingly, the average loss in FL for those with 2 delinquencies is only 2.1%.

FICO Score Range

LendingClub doesn’t disclose the exact FICO score of a borrower, but instead group the scores in ranges. In October 2012 the ranges changed from 6 to 42, becoming much more granular. In Interest Radar, the available ranges to filter loans are 5: 660-679, 680-714, 715-749, 750-779, and 780+.

Debtors with scores lower than 660 are turned down by LendingClub.

In the mainstream credit industry, a FICO of less than 679 are considered below average, while above 750 are considered prime.

But in P2P lending, one must understand the average borrower coming to shop for credit is different. While there may be many creditworthy people hearing about P2P lending and coming for an unsecured loan with a 7% annual interest rate while they could obtain the same loan in a bank for a higher interest rate, there is a huge proportion of borrowers coming to P2P lending because they are being turned down for a new credit card. This means a completely different game when interpreting the FICO of a borrower.

For example, why would a 750+ FICO request an E-grade or less loan, with a minimum interest rate of 20.5%? There must be a reason for someone with such a pristine credit score to turn to the secondary market and be willing to pay over 20% interest rate. No wonder you get a loss rate of 8% when you invest in this kind of loan, while only 7% when you switch to less than 715 FICO.

Loan Length

The Loan Length, or Loan Term, is how many months the borrower will have to payoff the loan. LendingClub offers 36 and 60 months (3 and 5 years) loans.

From a credit standpoint, longer term loans are easier to pay, as the monthly installment is smaller, but they have a higher interest burden, with each installment carrying more interest than a shorter term loan with the same interest rate. For example, a 10,000 dollar loan with a 36-month term and 20% interest rate will have an installment of $371.64, and the same loan with a 60-month term will require a installment of $264.94. Both installments will have a charge of around $166 only in interest in the first month. That mean the 36-month loan installment will have 44% of interest in the first month (and therefore 56% amortization), while the 60-month loan will have 63% of interest in that first month (only 37% amortization).

From an investor standpoint, the yield of a 60-month loan is greater than its 36-month counterpart, but the risk is higher: not only 2 more years for the borrower to default on their obligation, but also we have to consider that if a borrower chose to pay more interest for the same amount just so they would be able to pay the installment every month, it means their budget is tight.

But in the context of LendingClub, the highest source of risk in 60-month loans is the fact that there is no enough history to predict how this type of loan will perform after its first 26 months (the oldest 60-month loan in the site was issued in May 2010).  The predictions are optimists, as default rates are much higher in the first months of a loan, and tend to stabilize as it matures, but we will have to wait to see.

Added to that, LendingClub’s Prospectus states that any payment received from borrower after the first 5 years after issued is not paid to lenders. Hopefully this will be immaterial as only very few loans will be late in the end of their lives, but, again, we will have to wait to see.

Credit Grade

The Credit Grade is normally the first attribute in a loan you will be looking at or filtering by.

LendingClub determines the Credit Grade of a loan based on the FICO score of the borrower and some loan attributes such as the loan term and the amount requested.

The Credit Grade is a letter followed by a number, in a scale that goes from A1 to G5, where A1 is the most creditworthy borrower and G5 is the grade with the highest indication that there is a risk of default on the borrower’s part. LendingClub claims to turn down around 90% of the borrowers on the basis of credit risk, so even G5 loans made through a narrow cut by the site. The grade also determines the interest rate of the loan, A1 having the lowest rate and G5 having the highest.

Your only objective in P2P lending could be summarized this way: finding the loans that were “incorrectly” classified, i.e., they were assigned a high interest rate but the borrower is not defaulting on the loan.

The interest rates for each of the grades fall in the following ranges:

A: 6.03% to 8.90%
B: 10.16% to 14.09%
C: 14.33% to 17.27%
D: 17.77% to 19.72%
E: 20.49% to 22.47%
F: 22.95% to 23.83%
G: 24.70% to 24.89%

For a detailed list of grades and interest rates, visit https://www.lendingclub.com/public/how-we-set-interest-rates.action

Given that you will account for some loss in your portfolio due to defaults, it is very hard to get a return rate close to the nominal interest rate of the loan. That is why investors should consider only C-grade loans or lower accomplish 10% returns, and, if possible at all, E-grade loans or lower to get close to 15%.