Monday, July 02, 2012

Guest Post: Socially Responsible "Social Lending"

I am switching to the new Lending Club historical loan data file with data up to date from the latest quarter. As I need to spend time to clean up the data file and organize it for further analysis, I inquired Mrs. RT if she will be interested in writing another blog post. She gladly obliged. I think we make a good partner in this P2P Lending and Blogging project.

Socially Responsible "Social Lending"

Mr. RT again invited me to write a blog post. I don’t know about you, but because I enjoyed writing the blog post last time, I gladly accepted his offer and decided to share my view on social lending. Let me know through comments if you enjoy my posts and any suggestions you may have for me.

Recently there was a post on Reddit about P2P lending. It’s interesting to find various views and opinions and both bad and good experiences. I learned a few things.

Going to Las Vegas?

Someone mentioned social lending could be considered as gambling. I had read the similar comments at other places made by a few lenders who got burned. I don’t consider social lending as gambling in Las Vegas. It can become gamble, though, if only high return is pursued when selecting loans or if big money is invested on small numbers of loans (i.e. no diversification). Even with careful review of loans for investment, risk is definitely associated with social lending. Risk is not comparable to saving money at bank or investing on index funds. It’s important that lenders understand that they may lose money like all other investments.

As Mr. RT and I have been lending through Lending Club, let’s take a look at their web site. Overall the site is easy to navigate and the information is presented very well, except for information about lending risks and collection process. This type of information can imply negative investment experience for lenders. There’s no bullet points, no color, no graphs to explain risks. It’s just dry text and it appears to be one of those fine print materials that any seller wants to hide from buyers. I’d imagine Lending Club doesn't want to publicize investment risks to lenders. But, they could provide better graphical statistics to show the level of risks based on investment amount of each loan or number of loans invested, for example. They have done great job presenting all other data so that lenders can pick loan easier. Why not they can present associated risks in the same way?

Empowering through Lending

Back to the Reddit post. I felt good about finding out happy borrowers’ comment there:
“I am one of those borrowers that you are making money off from. I really like the idea of p2p lending. I want to start investing at lendingclub when my debts are paid off and I have a little money to throw around.”
“…The loan I got to pay off my debit has really been helping me.”
This is what I meant by “empower” in my previous post. I feel empowered when I am helping someone by lending money, even though the amount is tiny ($25 per note). That’s one of the purposes for social lending to open up opportunities to common people to be able to lend money to common people, right?

I’d understand people trying to lower hefty credit card interest rates, which can be 18 to 20% or more, by switching to social lending. We all have seen that economy has been depressed much longer than it should be. Maybe some of us are lucky enough not to suffer from the housing bubble or unemployment; yet, it definitely impacted every one of us one way or another. Is there anyone who does not know friends who lost their jobs in the past few years or whose houses are underwater? I bet all of us know such friends or relatives unless you don’t have any. It’s not good for anyone, both lenders and borrowers, when many people suffer from huge debt. I feel that lending money through social lending platform can help the economy better at the grass-root level.

Lending the Main Street Way

Let’s examine borrowers’ side further. The following loans are found as featured borrowers on the Lending Club web site. Their loans have been issued already:
  • Home improvement for $24,000 at 15%
  • Wedding for $8,000 at 17%
  • Business loan for $5,000 at 20%
Interest rates for these loans are extremely high for my standards. For home improvement, can’t you get much lower rate through home equity loan? If there’s no equity, do you still need to add more debt on not-so-worthy house? Wedding can be once in a lifetime event, but do you want to start new life with debt? Borrowing $5,000 and paying $1,000 as interest for business? I hope your business becomes profitable right away!

I consider these loans to be unreasonable and they just do not make sense to me. I suspect high interest rates were applied to these loans because of borrowers’ low credit score. LC clearly defines the loan grade and interest rate according to borrower’s credit score. There is a 10% of difference in interest rate between a borrower with 780 credit score and a borrower with 660 credit score. Ouch!

Both Mr. RT and I grew up in two different countries outside USA and left our own countries as young adult. We had to learn about personal financial system in the US from scratch. We made some not-so-financially-smart decisions when we were young; paying tuition via credit card, opening new credit cards and transferring money just for zero percent introductory interest rates, etc. I had no clue about credit score, how important it is and how it determines the interest rates. I wish I could have gained those knowledge much sooner.

For someone who grew up in this country, how difficult would that be gaining knowledge on credit score and making smart financial decision? As lender, I feel responsible not to lend money to such financially irresponsible people. We should not act like the financial institutions that encouraged people to borrow money irresponsibly to buy an house people can't afford. In the end, not only borrowers got hurt but also everyone lost something in one way or another. Having said that, I am passionate about educating personal finance to people who are disadvantaged in some way (i.e. recent immigrants, the oppressed).

I am hoping social lending platforms don't become like the traditional financial institutes, who seem to never learn. Remember recent JPMorgan Chase's $2 billion loss on risky speculative investments? And I, as lender, should be responsible of not nurturing irresponsible financial behaviors. That's all I want to say about socially responsible social lending.

Thank you for reading!

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