Should you include 60-month loans in your p2p portfolio?
Bo Brustkern walks through an analysis of how Term can impact Return.
Summer: A reader of the Lend Academy blog posted a poll on the Forum asking investors if they favor 36 or 60 month notes. Bo: can you weigh in on this?
Bo: As of this filming, there have been 45 respondents to this poll, and a full 70% have said that they prefer 36-month loans. Stay tuned and we’ll offer a link so you can go vote.
Summer: Are 36 month notes a better option?
Bo: In order to answer that question, we analyzed data from the NSR Platform and it turns out that 60 month loans are faring better than 36s.
Take a look at loans originated between January 2010 and December 2013, which offers more 4 years of performance data.
When we analyze the Return on Investment and charge-off statistics for each grade, for Lending Club, we find that results were either even (in the case of Bs and Es), or in favor of the 60-month loans (in the case of As, Cs, Ds, Fs & Gs). The 60 month loans have out-earned the 36s by 1.4% per year for this broad cohort.
Summer: That’s surprising. Why do you think the ROI for the 60s is better than for 36s?
Bo: The simple answer is that the 60-month loans are priced materially higher for borrowers than 36s.
Summer: Why is that?
Bo: Because lenders can get away with it. People are generally willing to take a much higher rate of interest on loans that have a longer duration because the payments are so much lower. For example, take a $10,000 loan.
If you paid 9% interest for a 36-month term, your payment would be approximately $320 a month. If you paid 12% interest – 300 basis points higher – over a 60-month term, your payment would be approximately $220 a month. By spreading the loan payments over 5 years instead of 3, that’s $100 a month that feels like savings.
In the final analysis, people tend to prefer the 60-month loan because it offers a lower monthly payment, even if the interest rate is higher.
Summer: But are we increasing the risk of default when we invest in 60-month notes?
Bo: There are a lot of ways to answer this question because the definition of risk varies from person to person. But let’s take a look at the underlying borrowers: they actually appear to be stronger in 60-month cohorts than the 36s.
We again used the NSR Platform to analyze the data, and viewing 36s and 60s side-by-side, while holding Interest Rate constant at 15% to 16%, FICO scores are 19 points higher for 60-month borrowers, annual income is $10,000 higher for 60-month borrowers, and average inquiries were 25% lower for 60-month borrowers vs 36s.
Summer: So you like 60 month notes in the portfolio?
Bo: Yep. Overall, we like the 60 month notes.
Summer: Thanks boss!
Bo: You’re welcome Summer! For you Self-Directed people out there, take the poll… tell us what you think.