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Credit Variables Explained – Does Income Matter?

By Angela Ceresnie
August 5, 2013

Monthly Income is a pretty straightforward variable: how much money does the borrower make every month.   Of course one would assume this is a predictive variable – the amount of income one makes should directly correlate to their ability to repay a loan.  In most cases, this is true to an extent, but as income reaches a certain level it is no longer a strong predictor of risk.   Additionally, it is important to understand that Lending Club claims to verify 60% of the income for loans – which means that the income you are assessing may or may not be verified (another blog post to come on the correlation of these two variables).

Does Income Matter?

First let’s look at the distribution (with numbers adjusted to show annual income because that’s a lot easier to understand.):

monthlyincome

 

The distribution shows that, for the most part, applicants are making more than $30K / year.  This is likely due to Lending Club’s screening process which we know includes a Debt To Income cutoff (http://www.lendingclub.com/kb/index.php?View=entry&EntryID=186 ).  We will be discussing Debt to Income in a future blog post, but, in short, if an applicant has low income they are likely to have a high debt to income, which is bad… and could result in a rejection from Lending Club.

From seeing this, it seems that Lending Club will be doing a lot of the upfront weeding out of low income applicants – making this variable likely to be less useful on the investor end.

 

Is Income Predictive?

The answer is – yes…to a point.  Looking at the below graph, we see that as incomes rise, the Net Return grows.  This is almost all due to the reduction in default rate in the higher income bands.

 

monthlyincome1

 

Depending on your risk appetite, the amount of money you have to invest and your overall strategy – Monthly Income may or may not make sense to use.  It likely would never make sense to lend to applicants with less than $20K in income given that the Net Return is negative – but as we saw above there aren’t many applicants in this group.

In Conclusion

Income is available on the Filter Notes page in Lending Club and is probably a good filter to use.  Once you’ve defined what your risk appetite and investing strategy is, you can use it to effectively manage the expected default rate of your investments.  However, keep in mind the limitations of income given that it is used by Lending Club in their screening process as well.

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