I Bought 1,736 Partial Notes: Here’s What I Learned

It’s so much easier to buy debt than you might think.

All you have to do is go to Lending Club or Prosper, create an account, deposit some money, and you’re off the the races.

From 2013-2016 before I knew about buying mortgage notes, I bought 1,736 unsecured partial notes on Lending Club.

This article details my experience and explains why I think mortgage notes are a superior investment vehicle.

Lending Club - an online platform to buy unsecured notes
Lending Club – an online platform to buy unsecured notes.

How Online Debt Platforms Work

Lending Club is a crowd funding website where individuals can receive loans from or fund loans for their peers.

If you need to borrow money (e.g. to consolidate a bunch of high APR credit cards) then Lending Club might be for you.

On the flip side, if you have money you want to put to work you can invest as little as $25 to fund loans and earn money monthly based on the interest rate of the loan, which I think is primarily based on the borrower’s credit score. 

Loans are classified by letter A-G with A being the lowest interest rate (5-6%) and G the highest (25%+). 

Since you can invest as little as $25 per loan, you can effectively diversify against defaults a bit more by spreading out your risk among more loans; you’re less likely to lose $2,500 invested across 100 loans than you would investing $2,500 in one.

My Experience Buying Unsecured Notes

I originally wrote this post as an email to my mailing list in 2018, so below is a screen shot of my Lending Club dashboard from back then:

Lending Club Dashboard
My Lending Club dashboard in 2018

In total I deposited $17,681.25 so to calculate my current cumulative return the equation is: 

(interest + late fees – charge offs) / deposits 

($10,757.01 + $5.34 – $9,500.33) / $17,681.25 = ~7.14%

Since I deposited the money over 4 years and some of the loans are still active, the annualized returns require a bit more work to calculate, but at face value even if you take expected charge off rates into consideration it’s fair to conclude that I’m earning well under 3% annually despite my portfolio having a 20.82% weighted average.

Despite these poor results from Lending Club, the silver lining is that this experience has further solidified my opinion that investing in mortgage notes is the way to go.

Below are some of the lessons I’ve learned while investing in mortgage notes. 

Lessons Learned From Buying Unsecured Notes

1. Financial projections on unsecured debt are just a guess

For each loan grade, Lending Club attempts to provide guidance for what percent of those loans they expect to be charge offs.

Every year since 2013 this guidance was revised to be more pessimistic, and Lending Club even stopped offering Grades F and G because the charge off estimates were so far off.

Based on this press release from The SEC, it looks like Prosper has also had the same issue.

I can’t even imagine how many factors must go into these projections, and I’m really glad I’m not the guy making them up.

2. Secured debt is FAR more valuable than unsecured debt

A property secures the value of a mortgage note so if the borrower stops paying there is collateral to take back in order to recoup losses.

However, the debt available for purchase on Lending Club is unsecured debt that people use to consolidate credit cards, student loans, pay for vacations, etc. so if they stop paying there’s nothing to take back.

Even worse, because Lending Club is a black box, there’s not much you as an investor can do to influence the debt collection process; either Lending Club is able to collect some of the money or they don’t, and in my experience they usually don’t.

Worse still, if the borrower files bankruptcy this debt might be wiped out entirely as a part of a bankruptcy payment plan because the debt is unsecured.

3. No matter how much you diversify, garbage is still garbage

One of Lending Club’s big selling points is that you can invest as little as $25 per note to diversify your risk.

I even wrote above that you’re less likely to lose all of your money if you spread it out across 100 loans than if you put it all into one, which I think is mostly true.

However, the fact is that unsecured debt is unsecured debt; it’s only a good investment if you have enough information to make good decisions and can buy the debt at a huge discount.

When you buy a loan through Lending Club you don’t get it at a discount, and you certainly don’t get as much information as I now know you need.

4. It’s good to be in control

If you made it this far you might think that I hate Lending Club, but that’s not true.

I won’t invest my money with them anymore, but I have to concede that I think the business model is pretty genius in an evil corporation sort of way.

Lending Club doesn’t really make their money off of loans and at face value they don’t really have much risk. 

Effectively, Lending Club is just a platform that connects borrowers and lenders and provides low quality due diligence tools and basic servicer capabilities.

The majority of risk is shifted to investors, and similar to Richard Pryor’s character in Superman 3, Lending Club makes its money pennies at a time (via tiny servicing fees). 

Final Thoughts

I haven’t technically lost money investing with Lending Club unless you factor in opportunity costs and inflation, but I certainly have learned a lot.

I’ll happily continue purchasing mortgage notes that are secured by real estate

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