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The loans that I invest in pay a fixed amount of money per month. A portion of it is principal and another portion of it is interest. As the loan matures, a smaller proportion of each payment is interest and more of it is principal.

I thought it might be profitable to hold the loan for about a few months after funding it and then sell it to another investor with a large fraction of the principal still intact. I ran some calculations on a spreadsheet. I earn 25% of the interest in the first 11 months of a 60-month term loan at 20% interest, and then immediately sell the loan off to recoup 90% (the remaining principal) of my original investment. So I earn $15 on my original $100 investment in just 11 months. Then rinse and repeat.

If I hold the loan until maturity instead, every additional month I hold it for earns me less and less interest (as a percentage of my original investment), meaning each period of time spent holding it is less profitable. I might as well get my principal back as soon as I can.

My experience with P2P lending is that the loans are riskier earlier in the term, so ironically, I currently like to purchase loans that have an 18-month history of on-time payments from the secondary market. Therefore, the higher amount of interest earned in the earlier periods is countered by the higher risk, which can easily eat into the profits.

Am I missing something crucial from my assumptions, or is this generally correct?

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every additional month I hold it for earns me less and less interest (as a percentage of my original investment), meaning each period of time spent holding it is less profitable.

Well, this is the fallacy. Say I lend someone $10,000. And the deal is to pay 1% interest each month along with $100 in principle. This would make the math simple, as each month, the loan balance drops by $100. But. 50 months in, they only owe me $5000, and the $50 in interest is less than 1% of my $10K. Because it's on the $5000 still owed. It's incorrect to look at the original amount lent. You need to look at the current rate you are being paid on the current balance of the loan.

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  • Seems correct. I ran another simple calculation on a 60-month term loan at 20.00% interest to confirm. The payments made monthly are all $2.32682508. The interest portion of the first payment is $1.16666667 for $100.00 of principal. But the interest portion of the last payment is $0.02683324 for $2.29999185 of principal. Suppose I had 43 of such loans making their last payment. Their combined interest payment would be $1.15382932 for $98.89964955 of principal. It’s off by a little bit because the division isn’t very even, but I think that illustrates the point for me!
    – Kevin Li
    Jul 12, 2019 at 16:59
  • Glad to help, thx for the 'accept'
    – JTP - Apologise to Monica ♦
    Jul 12, 2019 at 17:00
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Am I missing something crucial from my assumptions

The second to last paragraph is what's missing from your math.

The "first 11 month default rate" must be determined, and deducted from the "* earn $15 on my original $100 investment in just 11 months*" profits.

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  • Given the high “mortality rate” of fresh loans, I suppose I’m better off getting loans off the secondary market—ones that have a payment history of about a year to a year and a half. I worked out the math and it appears that the loans pay the same interest throughout their lifetime. I might as well buy the safer, more mature ones than to play dice with newly issued ones. I get one straight-roller borrower and I’m down $50.00—best to avoid since these P2P lending companies don’t seem to have any teeth with regards to chasing delinquents.
    – Kevin Li
    Jul 12, 2019 at 17:06

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