Forget ApplePay: Personal Loans Will Kill the Credit Card

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On Monday, LendingClub announced that it is looking to raise up to $692 million in an initial public offering. That would value the business at around $4 billion. The business has attracted high profile investors (Google (GOOG)), and directors (Lawrence Summers). It has also helped facilitate more than $5 billion of loans to borrowers, and investments to investors.

But is the hype worth it?

Borrowing Money is Expensive

American consumers have charged more than $800 billion on their credit cards. And they are paying very high interest rates on those credit cards. These high rates help banks generate incredible profits from their credit card divisions. Credit card businesses usually have higher returns than investment banks.

Borrowing money costs far too much in this country. With interest rates close to 0 percent, there is no reason that consumers should be paying 15 percent or more to borrow money. LendingClub looked at these high interest rates and sensed opportunity.

If you are looking to earn a good return on your money, it can be challenging. Simple savings accounts pay basically no interest. Most traditional banks are paying 0.01 percent on savings accounts. To get the best deals, you have to go to a branch-free bank, where you will still only be receiving 1 percent.
High yield bond funds (close to junk bonds) are only paying around 5 percent.

LendingClub looked at the amount of risk required to get a 5 percent return and sensed an opportunity.

Taking the Banks out of the Equation

Banking is actually a very simple business model. A bank takes money from depositors and lends it to borrowers. The difference between what it charges the borrowers and pay the depositors is its profit.

It seems outrageous that banks can pay 0.01 percent on savings account deposits and charge 15 percent or more on credit cards. So, LendingClub decided to create a new platform that removes banks from the game.

If you invest in the platform, than you are lending money directly to borrowers. You can invest as little as $25 in each loan, and you can see the credit profile of each individual investor. At a $25 minimum investment, you can quite easily build a diversified portfolio of more than 250 loans. After adjusting for losses, the average return on a diversified investment portfolio is about 7 percent.

And if you are borrowing from the platform, you can receive a much lower interest rate than offered by the credit card companies. By consolidating your credit card debt onto a LendingClub loan, you can cut your interest expense significantly.

What is the Catch?

If you are a borrower, there is no real catch. In fact, you can even check to see if you are approved without having a hard credit inquiry on your credit report. If you have credit card debt, you really should look to see if you can get a better deal from LendingClub.

LendingClub has been growing so rapidly, that many other people are copying the model. This is good news for borrowers, because they can shop around. MagnifyMoney has created a list of places where you can find personal loans, including the interest rate range. You will see a lot of names you don't recognize: this is the long list of LendingClub imitators.

If you are an investor, you should proceed with caution. Unlike bank deposits, these investments are not FDIC-insured. So, you could lose everything. And there is not a lot of history from these loans, given how young most of these companies are. But, investing in LendingClub can be an interesting part of a diversified investment portfolio, and can help you generate some real income.

Unlike bonds, you are receiving principal and interest repaid to you. So the cash flow is significant. Just make sure you invest in a broad enough portfolio. I recommend at least 250 notes; 500 is even better. If you invest in fewer than 250 notes, than you are basically gambling.

Is This the Future?

I think LendingClub is a great business model that will challenge banks to get better at their core business. For too long, we have allowed banks to pay far too little on savings accounts and charge too much on credit cards. LendingClub will do a much better job than any regulator ever could. With an innovative business model and competition, LendingClub should help investors get extra yield and borrowers pay off their bills faster.

Much has been written of ApplePay (AAPL) and its ability to kill the traditional credit card market. We must not forget that most of the money in credit cards is made from lending money, not from payments. And the real way to kill the traditional credit card market is to shift borrowing from plastic to an alternative channel. I hope LendingClub raises enough capital to become a very serious competitor to the traditional banking sector: it will be good news for all of us.

Nick Clements is the co-founder of, a price comparison website that helps your find the best deals in banking. He spent nearly 15 years in consumer banking, and most recently he ran the largest credit card business in the U.K.
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