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An In-Depth Look at Investor Service Fees

by Peter Renton on September 19, 2012

No investor likes fees. But for many investments, including p2p lending, fees are a part of life. The topic of investor fees at Lending Club and Prosper is not one that has been covered in depth anywhere until now.

This is detailed post that took me a long time to put together but if you read the entire post you will have an excellent understanding of how investor service fees work. But before we get started here is a quick primer on fees. All investors pay a 1% service fee . But how this fee is calculated differs at both companies. We are going to be looking at these differences and how it impacts investors at both companies.

Lending Club Investor Service Fees

Every time a borrower makes a payment Lending Club takes a 1% service fee. This fee is rounded up or down to the nearest cent with a minimum fee of $0.01. This fee is a fixed rate and will be charged on any payment whether it is a regular payment, partial payment or a loan payoff. This doesn’t mean that your returns are reduced by 1%, in some cases it will be more and in some cases less.

Here is the explanation of how these fees work from the Lending Club site. This explains why the impact of the 1% fee is in fact less than 1% in most cases:

We charge investors one percent (1%) of all loan payments. This service charge is designed to cover our costs for servicing loans, making Note payments and maintaining investor accounts. The 1% service charge impacts investors’ annual returns by less than 1% because it is not an annual charge. The average impact of the 1% service charge on the annual returns of a 36-month Note is 0.72%, while the average impact on the annual returns of a 60-month Note is 0.41%. Here is the formula for calculating the impact of the service charge:

=RATE(36,monthly_payment* 0.99,amount_invested)*12-weighted_average_interest_rate for 36-month Notes and

=RATE(60,monthly_payment* 0.99,amount_invested)*12-weighted_average_interest_rate for 60-month Notes.

Example

Invest $100 at 10% over 36 months, you get a monthly_payment of $3.23. The impact of the service charge is then calculated with “= RATE(36,-3.23*0.99,100)*12-0.1″ This equals -0.6198%, meaning the investor would be getting a net of 0.62% less after fees due to the service charge. The investor’s net interest rate would then be 9.38%.

This assumes that a borrower makes on time payments for the duration of the loan term. If this happens then the impact will always be less than 1% on your returns. As we know, though, this does not always happen.

You can see the fees impact on your account in one of two places – you can see the breakdown of every transaction on your Account Activity page and the monthly total when you look at your monthly statement.

The Early Payment Problem at Lending Club

At Lending Club, because they are taking a 1% fee of each borrower payment, when a borrower pays off a loan early it can have a negative impact on investors. In extreme cases it is possible for investors to actually lose money when a loan is paid back in full immediately.

If you take a look at the table below you will see that for interest rates of 10% or below an immediate repayment of a loan will lead to a small loss for the investor. This loss is made up by the second payment but regardless a very early payment will impact returns at any interest rate because the fees will eat into a large portion of the interest earned.

Note AmountInterest RatePaid In FullService FeesNet ReceivedInvestor Gain
$1007.50%$100.63$1.01$99.62($0.38)
$10010%$100.83$1.01$99.82($0.18)
$10012.50%$101.04$1.01$100.03$0.03
$10015%$101.25$1.01$100.24$0.24
$10017.5$101.46$1.01$100.45$0.45

While a loan payoff with the first payment only happens rarely, my unscientific estimate is that it happens between 0.1% and 0.5% of the time, this is still something that Lending Club should address. However, I don’t think borrowers should be burdened with any prepayment penalties because that is one of the attractions of peer to peer lending for borrowers. And as investors we want good borrowers.

So, what I would like to see at Lending Club is one of two options. First, they could remove the investor service fee completely for all loans that are fully paid back on the first payment. Alternatively, investor fees should start on all loans with the second payment with no fees taken out for the first payment. Both these scenarios will ensure no investor ever loses money on any Lending Club note.

Prosper Investor Service Fees

Prosper takes a different approach. They take a 1% on the total outstanding principal so their fees reduce as the principal balance is reduced. This means that Prosper is not taking a portion of any interest payments, only the principal. An early loan payoff is actually good news at Prosper because service fees will have not had much time to accumulate.

Here is the explanation of service fees from Prosper’s site:

Investors pay an annual loan servicing fee, currently 1% of the outstanding principal, subtracted from loan payments received. The fee is accrued daily, the same way that regular interest is accrued on the loan. It is calculated as: the annual servicing fee divided by 365 multiplied by # days since last payment, then multiplied by the outstanding principal of the loan.

In reality the Prosper service charge is slightly less than 1% of the outstanding principal at any one time because they annualize the fee. You can see this clearly when you view any of your notes on Prosper by clicking on Lending Accounting in the Payment History section on the note detail screen.

Different Outcomes for Loans Held to Maturity

For loans that are held all the way to maturity Lending Club is going to have lower fees than Prosper. An example of a $50 note with a three-year maturity at 15% the total fee at Prosper is around $0.78 while at Lending Club the amount is $0.72. The difference is even larger on 5-year loans where the same $50 note at 15% has fees of $0.60 at Lending Club and $1.16 at Prosper.

This assumes that every payment is made according to the amortization schedule. If a borrower makes two payments in the same month then service fees will be taken out of both payments. And if a loan is paid off in the first half of the loan term then Prosper will always have lower fees.

Minimizing Investor Service Fees

You may have noticed that the fees at Lending Club on a 5-year loan was less than on a 3-year loan in our example. The reason for this is that Lending Club rounds service fees to the nearest cent. So, if a monthly payment on a note is $1.49 then you will only be charged a $0.01 service fee on each payment, at $1.50 your fee doubles to $0.02.

If fees really matter to you then I recommend looking at an amortization schedule to see the monthly payment. I can tell you that if you are investing in $25 notes then you will be paying $0.01 in service fees even though payments will always be less than $1.00 for 3-year loans. This is why some investors prefer borrower payments to be greater than $1 and less than $1.50 so they are taking advantage of the rounding.

To take advantage of this rounding at Lending Club look at the amortization schedule and see the monthly payment of each loan. To make it easier for you I have included a table here with common note amounts and interest rates that also shows the monthly payments and Lending Club service fees.

Note AmountInterest RateLoan TermMonthly PaymentService Fee
$256%36 months$0.76$0.01
$2515%36 months$0.87$0.01
$2524%36 months$0.98$0.01
$256%60 months$0.48$0.01
$2515%60 months$0.59$0.01
$2524%60 months$0.72$0.01
$506%36 months$1.52$0.02
$5015%36 months$1.73$0.02
$5024%36 months$1.96$0.02
$506%60 months$0.97$0.01
$5015%60 months$1.19$0.01
$5024%60 months$1.44$0.01
$756%36 months$2.28$0.02
$7515%36 months$2.60$0.03
$7524%36 months$2.94$0.03
$756%60 months$1.45$0.01
$7515%60 months$1.78$0.02
$7524%60 months$2.16$0.02
$1006%36 months$3.04$0.03
$10015%36 months$3.47$0.03
$10024%36 months$3.92$0.04
$1006%60 months$1.93$0.01
$10015%60 months$2.38$0.02
$10024%60 months$2.88$0.03

The Last Word on Fees

While I know there are many people who are very concerned about these investor fees I am not one of them. While I think Lending Club should change their policy so no investor can ever lose money on a loan that is paid back in full, I don’t consider the fees themselves an important issue. Sure it could impact my returns by a few basis points but if I continue to get double-digit returns then I am not too concerned about them.

But what do you think? As always I am interested to hear your comments.

{ 19 comments… read them below or add one }

Zach September 19, 2012 at 10:54 am

This is a good article that analyzes some interesting perspectives that I never considered before. I like the $1.01-$1.49 monthly payment target concept; it could be difficult to factor in though.

Lending Club seems to make the service fees easier to understand for new investors, while prosper tries to make the fees more equitable for investors (but harder to understand).

I think a mixture of the two formulas could be beneficial in being fair and simple for investors to understand.

Reply

Peter Renton September 19, 2012 at 4:41 pm

Zach, That is a valid observation. Lending Club’s fees are very simple to understand, whereas even after all this research I still could not work out the exact formula Prosper used to determine fees. But I agree that Prosper’s fee structure is fairer to investors.

Reply

Roy S September 19, 2012 at 8:57 pm

I didn’t realize that LC rounds their fees to the nearest cent. I think Prosper rounds it to the nearest $0.000001, which I actually prefer (even though it may hurt my returns rather than help).

Someone, somewhere is going to have to eat up the loss. Either the borrower through an early payment fee, the lender (which is happening now), or LC. As I mentioned in an earlier blog post, I am not a fan of prepayment penalties. This is one case where I would actually support a prepayment fee, BUT I would make it only for loans paid off in the first month. The borrower is tying up money that could be used to fund other loans, and should therefore be the one penalized. I really don’t think the lender should be the one being penalized. Ultimately, I think the best move (public relations-wise) would be for LC to eat the loss, since they are the ones determining all these fees.

I can also see an argument being made that the lenders eating the loss is not bad, since according to your analysis their fees are overall lower than Prosper’s fees…

*Note: I’m not a lender on the LC platform, so my suggestions in no way impact my personal returns. Not sure this makes me truly unbiased, but I’d like to think that I am more so since the fee structure on LC doesn’t directly impact my returns one way or the other.

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Peter Renton September 20, 2012 at 9:03 am

Hi Roy, As I argue in the article I think that LC should eat the loss, I will cost them very little and as you point out it would be a good PR exercise for investors.

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Henry Miller September 22, 2012 at 7:48 am

If an investor has 100 or more notes, then first payment repayment will be a non-issue, but more like statistical noise. It is the overall fees that matter. Relative to near zero bank interest rates, P2P rates are good, provided due diligence is used in purchasing notes.

Reply

Peter Renton September 22, 2012 at 9:48 am

Henry, That is why I am not too concerned about service fees – because they are such a small amount. Even on my account that has over $60K in it my monthly service fees are still only $35-$40 a month.

Reply

Fred September 23, 2012 at 9:15 pm

Peter,

Thanks for this article; it makes fee comparisons much easier to do.

Also, could you please give an example for this statement: if a loan is paid off in the first half of the loan term then Prosper will always have lower fees?

The statement seems counter-intuitive since Prosper would collect higher fees in the beginning of the loan, that Prosper would collect 75% of total fees on the first half, and only 25% (of total fees) on the second half.

So, if a loan is paid off in the middle of loan’s term, Prosper would have higher fees than Lending Club would.

Anyway, this really is a good issue to bring up; I am now assessing my allocation between LC and Prosper due to fees.

Thanks,
Fred

Reply

Peter Renton September 24, 2012 at 6:20 am

It does seem counter intuitive but I have many examples from both accounts that demonstrates this. Here is a real life example. I had a $25 60-month note at 16.82% pay off at Lending Club after 12 payments. My total fees were $0.35. Of that amount $0.24 came on the last payment. At Prosper I had a $25 60-month note at 17.49% pay off after 15 payments. Even though there were three extra payments my total fees at Prosper were $0.29. I was being charged $0.02 a month and the last payment I was only charged $0.01. So, it is the final payment at Lending Club that makes the difference on loans that are paid off early.

Reply

Fred September 24, 2012 at 8:36 pm

Thanks Peter.

It looks like Lending Club calculates the projected fees throughout the loan life and collect them at the payoff time. $0.24 fee for a $25 60-mo 16.82% loan is a lot of money — about 4 months of interests!

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Peter Renton September 24, 2012 at 9:38 pm

That is not exactly true. Interest on this loan averaged around $0.32 during the first year of this loan. But the early payoff service fees certainly eat into the interest earned.

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Fred September 25, 2012 at 9:05 pm

Ah yes, you are correct: monthly interest on this loan averaged around $0.32 during the first year.

With monthly fee of $0.01 (rounded to nearest cent), LC basically exacts 2-yr of fees ($0.24) on payoff date.

Hmm ….

Peer-Lend September 24, 2012 at 2:55 pm

Great question, Fred – very important implications to “re-investment risk”, at scale (impact of defaults to return of principal + lower fees earlier in the lifetime of loan).

Reply

Zach September 26, 2012 at 8:11 am

Thought it could be important to point out that Lending Club does make a one-time balloon payment back to investors for overcharged investor service fees.

For example, if you have a loan that is making payments of $0.51 monthly, there would be a minimum service fee of $0.01 on each payment. Over the course of the loan, Lending Club roughly 2%-to account for this overcharge, Lending Club will make a balloon payment refunding an discrepancy over the 1%. Note that LC does not charge you for rounding errors where they get less at the end (than 1%). So, in this example, Lending Club collected $0.36 in service fees, but will refund $0.18 (truly 1%).

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Peter Renton September 27, 2012 at 4:16 am

Zach, I appreciate your comment and yes, I should have mentioned that. To be honest I was told this by Lending Club but I left it out of my article because I couldn’t see evidence of this refund. But when I looked a bit deeper after your comment I do see credits in my account for a few cents here and there which is this credit you are talking about. What threw me is that in the Account Activity screen it is put in as a payment just like any other payment from the borrower. It would be better if they had a description of “service fee refund” or something like that to make it more clear. I appreciate you clarifying this for myself and the readers.

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Em October 13, 2012 at 9:16 pm

How come I’ve never heard of this! Is it documented anywhere? Can you give an example of what to look for? And most importantly, is this “rebate” accounted for in Foliofn’s YTM calculation?

Now, I know most loans’ Payment Histories are chock full of rounding errors, for example Outstanding Principal almost never matches Principal Balance for a loan with more a few payments, sometimes it’s off by 10 or 20 cents. I’ve been ignoring it for the most part, but it’s always made me a little nervous that they can’t seem to get the numbers to add up. They’ve even helpfully added 12 decimal places precision to some of the fields (it’s hidden in tooltips on the table cells). Not sure how helpful any of that is exactly, especially since the numbers still don’t match Outstanding Principal!

Reply

Peter Renton October 15, 2012 at 10:10 am

If you go to your Account Activity page for most entries there is a Payment and then a corresponding service fee. But sometimes you will see a small payment and no service fee. These are typically the credits being refunded back to you. I am not sure about the Folio issues, I am only an occasional user of the Folio platform.

Reply

Em October 17, 2012 at 6:30 pm

So if I’m understanding what I’m looking at in this example, they’re taking 3 separate Account Activity entries, which all happened on different dates (one of which is this rebate), and then mashing them together into a single entry on Payment History.

1.23 + 39.76 + 0.06 = 41.05

WHO DESIGNS A SYSTEM LIKE THIS??? IT’S JUST WEIRD!!!!

Account Activity

252820442 10/13/12 PAYMENT PAYMENT, Loan 716825 $0.06

250853981 10/11/12 Lender Service Fee Service Fee, Loan 716825 $0.40
250853980 10/11/12 PAYMENT PAYMENT, Loan 716825 $39.76 $290.68

238716409 09/20/12 Lender Service Fee Service Fee, Loan 716825 $0.01
238716408 09/20/12 PAYMENT PAYMENT, Loan 716825 $1.23

Payment History

9/14/12 9/20/12 $41.05 $40.48 $0.57 $0.00 $0.00 Completed – on time

Peter Renton October 18, 2012 at 7:59 am

Em, Yes you have it correct. The final $0.06 payment is reimbursement for the rounding so you never pay more than 1% in service fees total on the loan.

Not a very intuitive system and one that I didn’t understand myself until a few weeks ago.

shu zhou March 21, 2014 at 7:47 pm

Hi, Peter,

I like this website, this analysis is mind blowing and Love it, Love it. even Round is such small number, but over time, it is huge and will affect the overall returns. from now, I will buy 3 notes for example rather than 1 or 2 notes.

Thank you,

Thomas zhou.

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