P2P Lending Woes: You Just Don’t Know Who to Trust

As savings rates slip in recent years, I’ve been slowly ramping up my investments in Lending Club loans. Lending Club allows a pool of investors to lend money (as small as $25 per loan note) to a borrower for a decent return. The riskier the credit profile of the borrower, the higher the potential return.

Now, three years after signing up for this peer-to-peer (P2P) lending platform, my first loans are starting to become fully repaid.

Although the P2P lending experience has been great, it wasn’t exact smooth sailing — I’m starting to see defaults and charge-offs. Some borrowers tout great financial profiles, but it doesn’t mean that they’re credible.

Given that P2P lending is still in its infancy, I’ve been conservative in the types of loans that I choose to invest in. The majority of my loans are to borrowers who have credit scores ranging from 680 to 740.

Other things I look for include: decent cash flow to sustain monthly payments in addition to monthly expenses, employment at the current job for at least 2 years, a respectable debt-to-income ratio, and no delinquencies or public records. I tend to prefer borrowers who work for larger, well-known companies and those who seek to consolidate their debt.

So far, I’ve been enjoying a nice return of 9.54 percent — better than any savings account or CD will give me.

Obviously, the return would have been higher if a couple of my loans didn’t end in default.

One borrower who stated that he or she was a dentist, with a credit score of in the upper 720s and no history of delinquencies or public records, requested a Lending Club loan of $15,000. The purpose of the loan was to consolidate credit card debt, a common goal among Lending Club borrowers.

Halfway into the 3-year loan, this dentist stopped making payments. I lost $5 of my $25 investment.

The other borrower who defaulted on me was even more of a surprise. This particular borrower identified himself or herself as a manager with a 10-year employment history at one of the largest mutual fund companies in the U.S. Again, this borrower boasted a pristine financial profile with a credit score in the low 780s, no history of credit problems and a monthly income of more than $9,000.

With those financial credentials, most investors wouldn’t care what the purpose of the loan was (it was for home improvement). But like my other experience, two years into the loan period, the borrower stopped making payments and I ended up recouping $20 of the $25 investment, and never saw my other $5.

How can you hold a commanding position at a major financial company and not be able to repay your loans? Furthermore, the ensuing crash in his or her credit score must have been pretty to watch.

As a result of these two charged-off loans, I’m now skeptical about my lending criteria. If even the “safest” potential borrowers — squeaky clean credentials, plausible incomes — failed me twice, why not just go for the riskier loans that come with much greater returns? I just don’t know whether a solid credit profile says anything about a borrower’s ability to repay.

But still, despite my diminishing confidence in Lending Club borrowers, a 9.54 investment return is still hard to ignore. The lesson to learn is that people who look good on paper reveal just that — they look good on paper, which isn’t necessarily a reflection of how they’ll perform in reality.