How do P2P platforms and Loan Originators make money?
P2P lending is a relatively new way of investing, which offers high return rates of 10% and more per year. Seeing these high rates, many people wonder how that investment can be legit and how the loan originators and platforms still profit.
In this way, we shine a light on the workings behind P2P platforms and Loan Originators and how they can afford to offer such high return rates while still making money.
How P2P platforms work
As an investor, you can use P2P lending platforms to invest in various types of peer-to-peer loans, such as consumer loans or real-estate backed loans. These are made available on the platforms by the Loan Originators.
You could view the P2P platform as a middle man between the investors and the Loan Originators that offers the infrastructure for both of them to do business with each other. Depending on the platform, it also obliges Loan Originators to have certain standards and stick to procedures, such as offering a buyback guarantee.
How do P2P lending platforms make money?
A P2P platform can make money from different channels. Sometimes they are combined, sometimes platforms only build their model on a single income stream. Let’s touch on the available options.
Listing fees. The listing fee is the fee the platform charges the Loan Originator to list their loans on the site. This is usually a one-off fee which can either be fixed or a certain percentage of the loan value provided to the site. A common range for this is 0.5 – 6%, greatly depending on the platform. As P2P platforms are a way to acquire additional capital for Loan Originators that are more easily accessible than issuing bonds, this money is often a worthwhile investment for them.
Ongoing fees. Another avenue is ongoing fees. Here the P2P platforms take a percentage cut off the paid back interest rate of the loans. Say the interest rate for the loan originator is 13%, but the platform takes 1% as a pay for their services, then you as an investor would receive 12%. It’s important to notice that charging the investors to invest on a platform is also a way for P2P lending platforms to make money. However, Lendermarket doesn’t use that approach and has a 0% fee for investors.
Secondary market fees. If a platform offers a secondary market, then they might impose a fee on each sale done on that market. In that case, the person who will be charged for selling their loans is an individual investor, but the fee is charged due to selling an investment before its due date. The fees vary by platform but are often between 0.5 and 1% of the value of the loans sold.
How do Loan Originators make money?
Now we know how the P2P platforms make money, but how can the Loan Originators afford to pay such high-interest rates? Imagine Loan Originators as private companies offering financial services. This can include loans to people that can’t get a loan through traditional banks or in an environment where normal loans are not available. Loan Originators are the meat and bones of every P2P lending platform. They provide the loans that the investors can then invest in, making the whole sphere more professional, compared to lending money to single individuals.
Interest rate difference. The business model of lending money is simple: You make money through the interest rates your customers pay. From that you have to subtract your capital cost, which is the interest rate you pay to borrow that money from somewhere else, be it bonds, banks or P2P lending platforms. Now you may wonder: If a company (Loan Originator) offers 15% on Lendermarket, how high are the interest rate charges? Especially if you come from a country like Germany or Austria, you might only know these interest rates from credit cards. The answer: Other countries such as Estonia, Lithuania, or even Spain can have way higher interest rates, especially for people that can’t get a loan with a traditional bank. Let’s touch on different loan types and their interest rates to the users / borrowers.
High-interest consumer loans. Countries usually have some type of financial background checking system, in Germany it’s the SCHUFA. If your score is bad enough, then banks will only offer you loans with high-interest rates – or none at all! Sometimes your score can even become bad through a chain of unfortunate events. When then a situation arises where you quickly need access to money, then you might need to explore other options, such as private companies offering loans. Due to the predicament you’re in, you’re the more likely to pick a more expensive option because you don’t have an alternative. That’s one reason why it’s important to have an emergency fund! The interest rates can then range from 20 – 40% per year. This leaves a lot of room for the loan originators to offer 15% on Lendermarket and still profit and have wiggle room if some payments default or come in slower than expected.
Payday loans. Payday loans are a type of short-term borrowing where you borrow the money until your next payday. They are characterized by very high-interest rates, even sometimes coming up to 1% per day. If you extrapolate this then you’re at an annual interest rate of 365%, again, leaving enough space to offer 15 – 18% as interest rates on a P2P platform.
Late payment fees and penalties. This adds on to the interest rate the Loan Originator charges the borrowers. If they are late with their repayment, then there can be additional fees or penalties. On Lendermarket you as an investor continue to earn interest even if a loan is overdue.
Conclusion: P2P lending offers high-interest rates for all involved
With P2P lending, you can make yearly returns of upward 18%, while still building on a business model, that can sustain these interest rates. Loan Originators might charge their borrowers anywhere from 20 to 40% a year, or even more if they offer payday loans. Therefore, there is a big buffer for additional capital to pay back your loans and still be operable, even if a loan may default. Hopefully this info allows you to better gauge your investment into P2P lending.
This content is for informational purposes only and does not constitute financial advice. Always conduct your own research and consult a qualified financial advisor before making investment decisions. Past performance is not indicative of future results and investing involves risks, including possible loss of principal.
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