P2P Lending Profits: Amortizated returns

When you are an investor in a P2P loan or a lender on a real estate crowdfunding platform in debt deals, your monthly payments or returns is a combination of principal and interest. Let’s get to calculating

Simple “CD style” return:

Certificate of Deposit (or CD in short) is a savings type investment vehicle that a bank offers which pays simple interest. Let’s say for example you invested $10,000 for a simple 10% return; at the end of the year you would have an extra $1,000 of interest income. This can be achieved in a CD or an annuity. It is beneficial to have FDIC insurance on a CD but the latest Bank of America return is a mere 0.08% APR AND let’s not forget an early withdrawal fees is levied (12 month maturity – so it’s not exactly liquid). Anyways, back to the topic – these fixed returns are simple non-amortized returns where your principal is still locked in the bank while you earn interest income.

Meh returnpenalty on withdrawl!

 

Amortized returns (or what you earn on P2P lending platforms):

Let’s invest a hypothetical $10,000 in a P2P loan loan. If the loan has an interest rate of 10%, then how are you returns calculated?

When you pay your mortgage it is amortized and you are paying bank both interest on their lent money as well as principal (you pay down your debt this way!). Similarly the borrower will be paying an investor both interest and principal. What is important to understand is how interest payment is calculated. While is annual or APR interest is fixed, it is applied to the OUTSTANDING principal remaining. So if someone owed $100,000 few years ago and now owes $50,000 to the same lender at a 10% interest, then yearly interest back to the lender will be 5,000 (by similar logic the lenders best returns on that 100K loan would have been first year where the lender earned $10,000 in interest).

Here is a quick formula: You can use Microsoft Excel/Google Spreadsheets or any spreadsheet program and use the PMT formula. The PMT function calculates the payment for a loan that has constant payments and a constant interest rate.

PMT(annual int rate/12, Loanterm, -InvestedAmount)

Using above example, if $ 10,000 invested a loan that is 42 months paying 10% interest would fit in the formula as PMT(ann.int rate/12, 42, -InvestedAmount)

=PMT(0.10/12, 42, -10,000) which returns $283.17

If you want yearly returns you can insert this formula; ((PMT(ann.Int rate/12, 42, -Investedamount)*42)-loan))

=((PMT(0.1/12,42,-10000)*42)-10000) which returns $1893.06

LendingClub or Prosper sample amortization example

You can also visualize such amortization HERE

It should be noted that we are not including 1% servicing fees that platforms such as for example LendingClub charges, or the tax you pay yearly on the interest income. You can use this formula to calculate your real returns: After Taxes Profits=((PMT(ann. Int rate/12,42,-loan)*.99*42)-Investedamount)*(1-Tax Bracket).  [the 0.99 takes out the 0.01 fees LC charges]

How investors boost returns:

The above returns assumes that you invested your money once and you do not reinvest your returns and let them just sit there. In reality, investors reinvest some or all of the returns and generate higher profit. It’s compounding – the 8th wonder of the world as rumored to have been said by Albert Einstein. Many calculators exist online but if you go to http://www.mycalculators.com/ca/yldcalculatorm.html a monthly reinvestment in a 10% yielding loan on a P2P platform will eventually boost returns to 10.47131% and so on and so forth as seen on this graph. This is how investors increase P2P lending returns.

Monthly reinvestment on P2P lending

While exact ROI calculation is subject to debate, industry investors usually use the XIRR() function in excel to measure the returns which just calculates the amount you invested vs what you have in your account at LC or Prosper.

Conclusion:

  • Returns on P2P Lending platforms are amortized returns. The monthly payment includes both interest earned and portion of original principal lent. Initial few monthly payments consist of mostly interest earned and last few monthly payments consist of mostly principal.
  • Regular reinvestments is how you can boost your returns.

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