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.
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.[table "35" not found /]
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.[table "34" not found /]
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.