Posted by Mike Smith :: October 2, 2007 @ 7:22 amIt may seem strange that Lending Club can offer better rates to both borrower and lenders. You might expect that better rates for one would mean worse rates for the other. As you’ll see, through low fees and reduced costs, it really is possible for both borrowers and lenders to come out ahead.
Banks
Banks incur significant costs to run their operations. Some of those costs include: collecting deposits, employing tellers and bank managers, managing accounts, servicing loans, paying for branch locations and office space, and advertising. I’m sure that you can think of additional costs.
Banks also offer many types of products and services. In addition to basic checking and savings accounts, they offer certificates of deposits, money market accounts, safe deposit box services, home equity lines of credit, personal loans, mortgages, and more. Some banks even offer investment and financial planning services.
It can get quite expensive for banks to offer all of these services, which in some cases are being provided at no charge (think “free” checking). In order to pay for it all, banks loan money out at significantly higher rates than they offer to their customers. Banks take money in from their customers by offering them interest on their accounts, typically at less than 5% and often as low as 0.5% or less. They then loan it out to other customers at much higher rates. Personal loans by banks have an average rate of over 12.5%. That huge difference in interest rates allows banks to cover all of their high costs and still make a healthy profit.
Lending Club
Think about Lending Club’s costs compared to those incurred by a bank. Lending Club doesn’t have all of the physical buildings, ATMs, and employees that a bank would have. Lending Club also doesn’t offer a ton of products. By offering only P2P loans and making that product offering as efficient as possible, Lending Club is able to keep its costs much lower. So instead of having to offer lenders low rates and borrowers high rates to cover all of its costs the way banks do, Lending Club is able to offer both parties a much better deal. Lending Club charge lenders a 1% fee over 3 years and charges borrowers an origination fee ranging from 0.75% to 2% (charged once up front, and amortized over 3 years). Since the origination fee is being charged only once, it only adds a fraction to the annual rate paid by the borrower. In this way, Lending Club is able to cover its costs and make a small profit.
Lending Club can offer better rates to borrowers and lenders because (a) its operational costs are so low compared to those of banks and (b) because it does not take a margin on the interest rates, but rather passes those savings on to its customers. To me, that’s a much better way to do business. There’s also a nice sense of camaraderie when you use Lending Club, as borrowers and lenders come together to make the P2P loan business beneficial for everyone involved.
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