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LendingClub Trading Alert

LendingClub Trading Alert

"Man Looking at Loss" by digitalart on freedigitalphotos.net

As I do more and more research in the LendingClub trading platform operated by Folio, it seems riskier and riskier. The notes trade very similar to bonds and if you aren’t knowledgable on bonds and how they are priced, then you can lose a lot of money. Let me try to explain one pitfall that I see for the average person out there that thinks they’re doing something similar to lending if they buy a note.

Principal

The “principal” is the base amount of money that the borrower borrows. This value is one of two basic parts of every note. The other part will be covered further down. A portion of every payment that a borrower makes goes to the principal of the note. If a borrower pays more than the minimum payment, the extra amount all goes to paying the principal. This brings me to point #1, if the borrow pays the loan off early then you will miss out on future interest. This is not a huge problem if you are an original lender since you are promised to get your principal back. This is a huge problem if you are a buyer of a note that has been priced above its outstanding principal. More on this later.

Interest

The “interest” is the extra amount of money that a borrower pays for the privilege of getting a loan. It depends on the loan’s interest rate, which depends on many other factors such as the borrower’s credit worthiness. The interest portion of a note is not guaranteed. The only way you get the full amount is if the borrower pays every month through full life of the loan. If the borrower pays the loan off earlier, then you miss out on all interest that hasn’t been paid.

Danger

Here is the danger when you are buying notes on the trading platform. If you buy a note at a price that is higher than the outstanding principal left on that note, then you have more to worry about than the loan defaulting. You also have to worry about the borrower paying the loan off early! We all know we lose money if a loan defaults. I am not going to explain defaults here. I do want you to pay close attention to the outstanding principal on notes and make sure you want to take the risk of paying more than what’s left.

Say you see a note for a loan that originated at 15% and the borrower has been paying the loan off on time for a year. You may be tempted to purchase the note at a premium and still be able to receive a  perceived 13% return if all goes well. Chances are that you will be paying 2-3% more than the outstanding principal left on the note. These are not exact numbers, but they’re close to how it works. If the borrower decides to pay the loan off in full the next month, you’ve lost 2-3% on your investment.

I would suggest that you purchase notes that are selling at a discount or as close to par as possible. Keep in mind that there is probably a good reason that a note is selling at a discount so do your research!

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Categories: Investing, LendingClub
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