There has always been divided discussion on how to calculate annual ROI. LendStats takes the equation for ROI and substitutes interest / rate for principal. This has the advantage of being simple and also capturing uniform ROI information across all loan terms (36 vs 60 month). Nickel Steamroller uses this method.
Another ROI metric that does not get much mention is total ROI, or the total amount of interest earned if you did not reinvest and allowed loans to mature. It has one unique advantage… it’s not a number that leaves much to dispute.
The highest rate of return you will earn on a note is the first payment, from that point forward your return diminishes. That’s worth repeating! The highest rate of return you will ever see on a note is the first payment.
Why you might ask? Take a look at this loan repayment chart
Everyone knows (or should know) when you buy a house, the first few years of payments are mostly interest. Figuratively speaking, you put a small dent in the principal. This is where the banks make the most money on your loan. Interest is the amount of money you pay for the privilege to borrow, and in the lender’s eyes, the more the better. This is why banks rely on people refinancing loans every 7 or so years, and also why they end up selling the loans to the government after they’ve held the loan for a short period (relatively speaking). As the amount of interest payment decrease, the monthly ROI decreases as well.
The chart tells an interesting story and it’s important to understand that all of the ROI numbers advertised by LendingcClub and Prosper are largely the results of these first few mostly interest payments. You have to constantly reinvest your money, or you are reducing your interest payments. Even a week of idle cash will have an impact, albeit small, on your real ROI.
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This table helps you understand what your annualized returns on LendingClub would be if you purchased loans and then let them sit to maturity. It does not paint a pretty picture, and goes to show how vital the first loan repayments are for your ROI and the need to constantly reinvest. This table also helps illustrate if you wish you end your P2P account, letting loans mature is not wise. I would be better to put all the notes on the secondary market.
I wonder if people will try to treat the secondary markets like the banks treat Fannie and Freddie, simply taking the initial interest payments then dumping the loan leaving much of the principle intact? I believe the 1% selling fee is enough to discourage this, but if that fee was ever reduced you can be sure this type of activity would ensue. Another thing to consider is that unless a note is heavily discounted, buying aged notes doesn’t make the most sense. There is little interest left and little return to be had.