For the past 2 years, I’ve been investing in consumer debt via Lending Club, which is kind of like a crowd-funded credit card company. When people need personal loans, they can go to a place like LC where people like me chip in money for them to refinance credit cards, renovate a kitchen, build a pool in their backyard, etc. One personal loan could be funded by as many as 1400 different people (loans are up to 35k, and you can invest in “notes”, which are multiples of 25 dollars).
During the 26 months that I’ve been participating in LC, my investments have done pretty well. I’ve averaged a return of just over 7% per year. All things considered, I’m pretty satisfied with the way things have turned out. What really surprised me is how most people are diligently paying off their debts. Only 5% of the people I loaned money to are late or in default on their debt.
Each loan application has information that the prospective borrower has to fill out that lenders like me can look at. None of the information can be used to identify the borrower, but we do get to see things like their salary, credit score, location, and whether they rent or own. Every time I see that a note has gone into arrears, I take a look at the profile of the loan.
Some of those loans get marked in the books as a total loss. You can see a steep drop in the borrower’s credit score when that happens. The borrower usually files for Chapter 7 bankruptcy and then their debt obligation gets charged off. Half of the deadbeats are garden variety cases. They don’t make a lot of money and borrowed a decent amount at a high interest rate.
But the other half gave me a pretty big shock. They all made good money (two of the borrowers had income in the low six figures, the other 3 made at least 80k/y), had good credit scores and low amounts of debt, and yet they still failed to make payments on the loan they took out from LC. There’s a very weird feeling you get when a person who makes more money than you defaults on a loan you gave them.
If you’re making 165k per year and you live in a suburb of Philadelphia, there’s no reason why you shouldn’t be able to make payments on a 15k loan. And yes, that’s a real note in my portfolio that got charged off after the borrower filed for Chapter 7.
Don’t get me wrong; I’m not particularly bothered by the fact that a few of the loans I made went bad. But I am surprised that quite a few of those bad loans were made by people who were doing pretty well in life.
And I’m sure they all have legitimate excuses as to why things went bad. But the truth is they shouldn’t have been borrowing money in the first place. When you’re that high up the income ladder, you should be saving as much money as possible because there’s a long way to fall if something goes wrong.
“I don’t make enough money.” That is the most common reason people give when they justify their lack of saving. People think to themselves, “if only I made 10, 20, 30k more per year, then I could really build up my savings”. But in most cases, they’re just kidding themselves. A lot of people reach their magical salary number where they said “that’s when I’ll start saving” and just spend all of that money instead.
The Honda gets ditched for a BMW. The crappy rental is quickly forgotten as you sign the lease to your new luxury apartment. White tablecloth restaurants become the norm after years of Mickey D’s. Your low rent wardrobe gets upgraded with clothes from upscale European fashion houses. The modern economy is designed to make it extremely easy to spend money while saving money has become a herculean feat of self-restraint and discipline.
If you want to borrow some money, guys like me will be more than happy to lend it to you. But borrowing to finance your lifestyle is one of the most destructive things you can do. About 2/3 of the loans on Lending Club are used to refinance credit cards. If you’re a recovering shopaholic, it makes sense to consolidate your debts into a lower interest rate. But you’ll be much better off if you don’t pile up consumer debt in the first place.