P2P lending may be 5x better than savings accounts

In the 90s, money sitting in a savings account could gather around 5% annual interest. That’s risk-free money compared to the stock market, which has historically returned just under 10% annually.

In 2017, the most competitive savings account in the US will get you about 1% annual return. $1000 would net you $10 after one year.

(With an average inflation rate around 3%, your money is actually losing value.)

This got me thinking: what alternatives can I find instead of my shitty savings account?

It’s money I don’t plan on touching anyway, so if I can get a low-hanging win by just parking my money elsewhere, why not?

If you’re like me, then you also like free tacos money.

To find such an investment vehicle, I had a few requirements:

  • Offers higher than the highest savings account returns
  • Predictable returns (less volatile than stocks)
  • Easy to use and automate (I like “set it and forget it” options)
  • Relatively safe

I found my answer in LendingClub, a peer to peer lending marketplace.

I first learned about LendingClub through a coworker, then read about the opportunity for sizable returns on Mr. Money Mustache. Since then I’ve been getting an annual return of more than 5% for the past two years. That’s 5x my savings account rate!

Is it too good to be true?

Actually, no. Here’s how it works.

Peer to peer (“P2P”) lending works when a company brings together borrowers (people who need loans) and investors (people willing to provide loans).

LendingClub handles this through the issuance of $25 “notes.” If Johnny needs a $5000 loan, that requires $5000/25 = 200 notes on Lending Club.

As an investor, you can automatically invest money across different notes.

If I put in $2000 (or 80 notes), 10 of my notes may go to Johnny, 20 to Jane, and so on.

Borrowers are rated on a scale of A – E (A being the best) based on their credit scores.

You can choose purely A notes, but that’ll get you a lower return.

Investing in lower-grade notes will get you a higher return because you’re lending to riskier borrowers.

For that reason, I use Lending Club’s automatic investing option. You can choose your own mix across different grades of notes, and the money you put in will be invested according to that allocation as soon as a borrower matches your criteria.

You can tweak your allocation anytime with available cash that hasn’t been invested in notes yet.

Why I love this business model

Lending Club, IMO, has created a win-win-win business model.

Borrowers win because loans are cheaper and easier to get than traditional bank loans or those egregiously bad “payday” loan centers.

Investors win because with a higher rate of return than compared to savings. LendingClub also has great automated options so you can invest amounts you’re comfortable with and let the magic of (higher) compound interest work in the background:

In terms of risk, I see P2P lending as being a little riskier than savings accounts but much less risky than the stock market. A nice little bonus is that your cash balance is FDIC insured up to $250,000.

And of course, Lending Club wins because they charge fees for their service.

The Biggest Drawback to LendingClub

Peer to peer marketplaces aren’t perfect. The biggest drawback is that once invested, your notes are subject to loan terms. Meaning your money will be less liquid than if it were sitting in a savings account.

Loan terms are either 36 months or 60 months.

For this reason, I still keep money in a savings account in case of emergencies.

LendingClub does have a way around this called FolioFN, which allows you to trade your notes in a second hand marketplace:

The verdict? if you really need all your money to be liquid, don’t use LendingClub.

If you can set aside money for long term investments, then LendingClub can offer dramatically higher returns on money you’d otherwise let sit in a savings account.

Get a sweet bonus with LendingClub

Sign up with my referral link, and get up to a $400 bonus.


Personal policy: I only recommend products that I use myself. I’ve checked out Prosper (non-affiliate link) too but found the user experience to be more confusing.

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