There is a fancy term you should commit to memory related to what’s going on in the world of financial services: disintermediation. Investopedia defines it as a reduction in the use or total removal of intermediaries between producers and consumers – or more simply cutting out the middleman. If you have an extra $25 in your pocket- you can be a banker in most senses of the word to your fellow citizens who need money.
Consider the words of Renee Laplanche, the French securities lawyer and founder of Lending Club:
“I opened a credit card statement charging me a 16.99% interest rate, and a savings account statement from the same bank where I was earning a 0.48% interest rate on my deposits,” The chasm between what he paid the bank and what it paid him “made me wonder whether the existing banking system was indeed the most efficient mechanism to allocate capital.”
Technology has gotten to the point where it is now possible to easily connect large numbers of creditworthy borrowers with high interest credit card debt (18-24%), with investors looking for yield on their money in the 6-14% range.
More importantly the tech also enables the platforms such as Lending Club and Prosper.com to underwrite or determine the creditworthiness of the borrowers using a mixture of both classic (income, credit score) and proprietary factors that can be customized to the investor’s preference.
Below is a summary of my account at lending club (minus some details).
The basic premise is this: I have made a number of small loans (25$, which is the site’s lower limit) to hundreds of borrowers. Its this diversification that is your biggest safety feature. Ultimately these are unsecured personal loans, and a certain amount of them will go bad. The key is that if you have a large enough loan portfolio, the expected default rate will not significantly affect your anticipated yield. Research has suggested a portfolio size of at least 200 loans is required for adequate protection. The unadjusted interest rate assumes no defaults which isn’t realistic but is still substantially better than what I would be earning on this money sitting in my savings account.
The majority of my loans fit a conservative risk profile (grades A and B). Specifically this includes:
- a credit score > 700
- no credit delinquencies in the past year
- no charge offs or defaults
- and I only loan to refinance loans or credit card debt.
Research has shown that these refinancers are a pretty safe group. They are already regularly making debt payments that are substantially higher than what they will eventually be making once they get approved for their peer to peer loan. As you might imagine, since these are consumer loans, the requests run the full gamut of anything people spend money on: home improvement, vacations, small business, medical expenses including plastic surgery, etc. Perhaps I will branch out and fund some of these riskier categories in the future in a quest for higher yield, but for now I am going to continue to play it conservatively. By the way, the maximum loan size on the platform is $35,000.00.
Additionally the site provides a host of other factors that you use to further refine your search such as debt to income ratio, length of employment, and geography by state are available among others. A cursory web search will reveal a host of investors’ experiences using various custom filters which they swear by to give better results. I would encourage you to review their experiences and come up with your own.
So, I would encourage you to investigate this site, peer to peer lending in all its forms, and the whole emerging world of disintermediated finance. It is an emerging force that will eventually gain enough traction that it will be a mainstream investment option. Indeed Lending Club’s IPO in December was the 2nd largest tech IPO of 2014 valuing the company at 9 billion dollars, making it the 18th largest bank in the US! Founded in 2007, it took the company 6 years to facilitate 1 billion in loans; now they do that volume every 3 months.
Here’s to more Smartphone Money!
Don’t forget to comment and share.