Investors Get Better Returns With Social Lending

If you’ve been disappointed by the low interest rates offered on CDs or checking accounts recently, you might want to look into social lending.

Social lending is a new investment opportunity that matches individual lenders with individual borrowers. Platforms like Lending Club and Prosper cut out the complexity and overhead of traditional banks to offer better returns to investors and lower rates to borrowers.

How good are the rates for investors? Well, I’m currently averaging a 13.77% annual return on my investments at Lending Club and the average return there is over 9% for all investments since 2007.

Your personal rate of return there can vary significantly based on the types of loans you choose.

Here’s how social lending works for investors. First, you open an account online and deposit funds (typically $1000 is the minimum). Then, you decide if you would like to select loans to invest in specifically, or if you would like the system to choose loans for you based on your risk tolerance and other criteria.

Generally, investors choose to invest small amounts across tens or hundreds of different loans. For example, if you invested $1,000, you might choose to invest just $25 in 40 different loans, to reduce the impact of the risk of default from any one loan.

Loans you can invest in will carry different interest rates, based on the borrowers credit worthiness. Interest rates at Lending Club vary from about 6% to 21%, and borrowers must have a credit score of 660 or better. Your overall annual rate of return will depend on the mix of loans you invest in and how many of those loans end in default.

How risky is social lending overall? Does it really fit in the same category as investing in a CD or checking account? Social lending does carry certain risks that are greater than investing in an FDIC-insured product like a checking or CD account.

Social lending probably compares more favorably risk-wise between bond investing and stock market investing. The primary risks to you as an investor are that individual borrowers will default, or that the platform who administers the loans might stop servicing the loans altogether. The former will almost certainly happen, and can be mitigated by choosing your loans carefully and investing in many different loans at the same time. The latter is less likely to happen, and choosing the platform you invest through is critical. Prosper and Lending Club are the two biggest platforms in the U.S.

As an investor, you owe it to your portfolio to at least investigate whether social lending is for you. You may find that it can help you raise your returns in this low interest rate environment.

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