Author Topic: Interest Rate, Yield to Maturty (YTM) and Service Fees  (Read 10748 times)

Rob L

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Interest Rate, Yield to Maturty (YTM) and Service Fees
« on: July 01, 2016, 05:39:39 PM »
This topic may be basic "LC 101" for many but I needed to put it together for myself. Thought I'd share with any other Folio noob's that have to figure out the relationships between original loan interest rate, number of remaining payments and yield to maturity (IRR).

First the ground rules. There is no markup or discount considered, nor for that matter any Folio trading. The YTM's shown are those that an original note purchaser would compute both at loan origination and after each monthly payment. All loan payments are made on time and in full (no prepayments or late payments). LC's service fee is 1% of the monthly payment amount. For the example below, current LC interest rates were chosen for a 36 month loan.

The first thing to notice is that the YTM of a brand new note, zero payments yet made, is anywhere from 0.67% to 0.77% less than the quoted annual interest rate of the loan. Example, E1 interest rate is 22.39% and YTM is 21.65%. YTM is the annualized interest rate of the monthly payments to be received by us lenders AFTER LC has taken its 1% cut. Were it not for the LC fee, YTM would be exactly the quoted annual interest rate of the loan.

Secondly, since these are fully amortizing loans the monthly payment is a constant amount. As a direct result LC's monthly service fee is also a constant amount throughout the life of the loan. Whether it's 1% or 10% the borrower isn't concerned with the LC service fee and never sees it. The borrower sees their principal owed reduced by the full amortized amount for each monthly payment. So, given a fixed monthly payment amount and an amount guaranteed by the amortized loan agreement to go towards reduction of principal what we have left pays LC's service fee and we keep what is left after that as interest.

Thirdly, in a fully amortizing loan the amount of each subsequent monthly payment that goes towards reduction of the borrower's principal owed increases. That leaves less to cover LC's fee and to cover what we receive as interest. Since LC's fee is constant throughout the loan the ratio of what we are left with divided by LC's fee goes down with each payment (LC's share of the interest pie gets bigger). Every month our YTM falls because of this effect.

As you can see in the table, early in the life of the loan when the principal reduction component of the payments is small and the interest component is large YTM creeps down slowly. Towards the end of the loan when most of the payment goes towards principal reduction and interest is small YTM crashes (% Change Column is month to month YTM delta). It actually goes negative for the final 3 payments of an A1 loan and the final payment of a B1. Funny; someone should check my math. If true one cannot list their A1 note at 0% markup/discount with less than 4 months to go and comply with the rules of the road.

Edit: It is interesting that the month to month YTM delta is constant across original interest rates. An A1 drops the same YTM percent in any given month as a G1. That was surprising. Maybe it shouldn't have been.

I have marked two lines in the table in blue; 12 and 24 months into loan payments. After 12 months YTM is about 1% less than original interest rate and after 24 months it's about 2%. All due to the natural causes described above. Just the way it works.

For those who prefer graphs over charts here's the same data "visually":

Cheers!

« Last Edit: July 01, 2016, 06:37:41 PM by Rob L »

lascott

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Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #1 on: July 02, 2016, 12:11:26 PM »
Thanks for your continued efforts to share your learning and experience. Making a note of this thread for the future.
Tools I use: (main) BlueVestment: https://www.bluevestment.com/app/pricing + https://www.interestradar.com/ , (others) Lending Robot referral link: https://www.lendingrobot.com/ref/scott473/  & Peercube referral code: DFVA9Y

bobeubanks

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• Posts: 273
Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #2 on: July 02, 2016, 06:12:28 PM »
Perhaps I misunderstand YTM but I don't see why the YTM goes down. YTM assumes reinvesting interest/principle at the same rate, so shouldn't it not change as long as you are holding the note?

Rob L

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• Posts: 2049
Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #3 on: July 02, 2016, 06:51:37 PM »
Thanks for your continued efforts to share your learning and experience. Making a note of this thread for the future.

I really appreciate the reply and hope you find the info useful someday. My motivation came from having been thrown into the Folio deep end without a life preserver. I had led a sheltered life as a buy and hold'er type investor from the primary platform and Folio was always the Lewis Carrol land of Cheshire cats. Now I'm attempting to deal with Folio as a seller. Were I a Folio buyer and I saw a YTM of 21.65% on a brand new E1 note that has an interest rate of  22.39% my thought would have been that the seller was somehow getting a 0.74% benefit. It ain't so, as I figured out in this post, but that would have been be my perception. LC could have listed notes on the primary platform at YTM (net of their fees so everyone was on the same page) but they didn't and I sure wouldn't advise they do it now. Seems they need all the lenders they can find.

Fred93

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Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #4 on: July 02, 2016, 07:04:58 PM »
Perhaps I misunderstand YTM but I don't see why the YTM goes down. YTM assumes reinvesting interest/principle at the same rate, so shouldn't it not change as long as you are holding the note?

The issue really isn't about some aspect of YTM, or about reinvestment.  You can see this effect if you calculate some simpler return number as well.

Look at what he's calculating.  When he calculates from the middle of the loan forward, he's presuming that he has bought the loan at par, ie at a price equal to the balance, which is substantially lower than the original balance of the loan.  However, all payments are the same amount, so per unit time (month or year) the service fee payments will be the same as the original owner paid.  However, as a RATIO to the purchase price, these service fee payments look much larger to this second fellow!

Here's some simple math to try to give you the intuitive feel...

Thinking in simple interest terms ... If the service fee is \$1/month, that's \$12/year.  For a guy buying a brand new \$2000 loan, \$12/year looks like about 0.6%/year.  For a guy who bought the loan toward the end of its life however, say maybe when the balance was \$300, the service fees look much larger.  \$12 / \$300 = 4.0%/year.

The same effect occurs for YTM, but I won't try to show the arithmetic, because it would be really messy, and the mess would deny you the ability to see what is going on.

Rob L

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Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #5 on: July 02, 2016, 07:13:30 PM »
Perhaps I misunderstand YTM but I don't see why the YTM goes down. YTM assumes reinvesting interest/principle at the same rate, so shouldn't it not change as long as you are holding the note?

I may be the one misunderstanding, but let me explain the calculations I made. There was no reinvesting. I took a single note "as issued", fixed interest rate and term. There is no reinvesting in a single note; it's a done deal at issuance (baring prepayment, late payments, defaults, etc.) which I did not consider. A portfolio of notes is an entirely different matter and reinvestment is very often the norm (as was my own before 5/9). The point of the exercise was to understand why the original interest rate X of a single note and the YTM Y of that same note were not the same over time. It's a Folio thing. Folio buyers see YTM Y that is lower than Interest rate X for a loan they may consider buying and wonder why they are different. They start out different at the beginning by about 0.75% and this difference increases over time. Dramatically over the last few payments.

Rob L

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• Posts: 2049
Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #6 on: July 02, 2016, 07:19:53 PM »
The same effect occurs for YTM, but I won't try to show the arithmetic, because it would be really messy, and the mess would deny you the ability to see what is going on.

Yeah, the arithmetic is messy but for Excel it's just another =function().
The logic of the point you made was the exactly same I that I was trying to make myself.
« Last Edit: July 02, 2016, 07:25:21 PM by Rob L »

bobeubanks

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• Posts: 273
Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #7 on: July 02, 2016, 09:46:26 PM »
the service fee payments will be the same as the original owner paid.  However, as a RATIO to the purchase price, these

Ah yes. Thanks. I forgot that LC does fees that way.

Rob L

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• Posts: 2049
Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #8 on: July 04, 2016, 06:40:27 PM »
The implication of the negative YTM for the last 3 payments of an A1 loan is that we lenders get \$0.00 interest for all of them (presumably LC won't charge us) and LC gets less than their 1% service fee. There is simply not enough interest money from the borrower to go around. I know I've gotta be wrong about this, but someone please show me the error of my ways.

jz451

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• Posts: 118
Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #9 on: July 04, 2016, 10:27:45 PM »
The difference is that YTM is not the same as receiving interest. There will always be interest received and LC takes their \$.01/1% fee. That will always happen regardless of YTM because of the basic mathematics of amortization that interest is always accrued during each month.

The implication of the negative YTM for the last 3 payments of an A1 loan is that we lenders get \$0.00 interest for all of them (presumably LC won't charge us) and LC gets less than their 1% service fee. There is simply not enough interest money from the borrower to go around. I know I've gotta be wrong about this, but someone please show me the error of my ways.

Rob L

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• Posts: 2049
Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #10 on: July 05, 2016, 02:40:41 PM »
The difference is that YTM is not the same as receiving interest. There will always be interest received and LC takes their \$.01/1% fee. That will always happen regardless of YTM because of the basic mathematics of amortization that interest is always accrued during each month.

The implication of the negative YTM for the last 3 payments of an A1 loan is that we lenders get \$0.00 interest for all of them (presumably LC won't charge us) and LC gets less than their 1% service fee. There is simply not enough interest money from the borrower to go around. I know I've gotta be wrong about this, but someone please show me the error of my ways.

I think we agree but the semantics of the word "interest" confuses me. YTM doesn't have to be a part of the conversation. Negative YTM's are the by-product of the effect I described. Just to cover all the bases a sample amortization schedule is shown below:

It's pretty self explanatory. Fixed term, fixed interest rate, fixed monthly payments and fixed LC service fee. "Total Interest" is what nominally would be called interest for an regular old amortizing loan. "My Interest" is the amount I get to keep of that "Total Interest" after LC's service fee is subtracted from it. What gets interesting is when "Total Interest" is less than the LC service fee (as it is in the final two payments above). At that point LC cannot get its full 1% because there isn't enough "Total Interest" to pay it. Presumably I get zero in those cases.

I spent a bit of time looking through Folio for a real life example and could not find one. Maybe I didn't look hard enough or maybe there's another explanation that doesn't violate the law of conservation of money.

Fred93

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Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #11 on: July 05, 2016, 02:52:19 PM »
What gets interesting is when "Total Interest" is less than the LC service fee (as it is in the final two payments above). At that point LC cannot get its full 1% because there isn't enough "Total Interest" to pay it. Presumably I get zero in those cases.

I believe LC can always get its full service fee.  Whatever the borrower pays, LC takes 1% of it, and passes along 99% of it.

Lovinglifestyle

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• Posts: 899
Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #12 on: July 05, 2016, 03:51:39 PM »
The difference is that YTM is not the same as receiving interest. There will always be interest received and LC takes their \$.01/1% fee. That will always happen regardless of YTM because of the basic mathematics of amortization that interest is always accrued during each month.

The implication of the negative YTM for the last 3 payments of an A1 loan is that we lenders get \$0.00 interest for all of them (presumably LC won't charge us) and LC gets less than their 1% service fee. There is simply not enough interest money from the borrower to go around. I know I've gotta be wrong about this, but someone please show me the error of my ways.

I think we agree but the semantics of the word "interest" confuses me. YTM doesn't have to be a part of the conversation. Negative YTM's are the by-product of the effect I described. Just to cover all the bases a sample amortization schedule is shown below:

It's pretty self explanatory. Fixed term, fixed interest rate, fixed monthly payments and fixed LC service fee. "Total Interest" is what nominally would be called interest for an regular old amortizing loan. "My Interest" is the amount I get to keep of that "Total Interest" after LC's service fee is subtracted from it. What gets interesting is when "Total Interest" is less than the LC service fee (as it is in the final two payments above). At that point LC cannot get its full 1% because there isn't enough "Total Interest" to pay it. Presumably I get zero in those cases.

I spent a bit of time looking through Folio for a real life example and could not find one. Maybe I didn't look hard enough or maybe there's another explanation that doesn't violate the law of conservation of money.

I looked through a bunch of fully paid notes for similar real life examples.  The closest I could come was interest of 2c and fee of 1c on the 36th and final payment.  This other one was interesting if you look at the last two payments and notice the interest sum and the fee sum are each 3c, for a total of net 0 to the lender: (the 3rd \$column is the interest portion and the last column is the fee portion)

Purpose: Learning and training (Loan id: 419949)
Original Listing
Loan Summary
Note Issuance Date   7/1/09
Note Amount   \$50
Loan Amount   \$10,700
Rate   A5 : 9.63%
Term   36  months
Status   Fully Paid
Recent Credit Score   740-744
Credit Score Change ?
Up
Last Payment (8/13/12)   \$0.18
Payments to Date (36)   \$57.86
Principal   \$50.00
Interest   \$7.78
Upcoming Payments
Next Payment   \$0.00
Remaining Payments (0)   \$0.00
Expected Final Payment
Outstanding Principal   \$0.00
Accrued Interest   \$0.00
Payment History

<< < 123 > >>
Due Date
Completion Date
Payment
Amount
Principal Portion
of Payment
Interest Portion
of Payment
Principal Balance
Late Fees
Investor Fees
Payment Status
8/7/12   8/13/12   \$0.18   \$0.16   \$0.02   \$0.00   \$0.00   (\$0.01)   Completed - In Grace Period
7/7/12   7/13/12   \$1.60   \$1.59   \$0.01   \$0.16   \$0.00   (\$0.02)   Completed - In Grace Period
6/7/12   6/13/12   \$1.60   \$1.57   \$0.03   \$1.75   \$0.00   (\$0.02)   Completed - In Grace Period
5/7/12   5/11/12   \$1.60   \$1.56   \$0.04   \$3.32   \$0.00   (\$0.02)   Completed - In Grace Period

Rob L

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• Posts: 2049
Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #13 on: July 05, 2016, 03:52:20 PM »
What gets interesting is when "Total Interest" is less than the LC service fee (as it is in the final two payments above). At that point LC cannot get its full 1% because there isn't enough "Total Interest" to pay it. Presumably I get zero in those cases.

I believe LC can always get its full service fee.  Whatever the borrower pays, LC takes 1% of it, and passes along 99% of it.

And if that remaining 99% isn't enough to cover the required principal repayment amount?

Rob L

• Hero Member
• Posts: 2049
Re: Interest Rate, Yield to Maturty (YTM) and Service Fees
« Reply #14 on: July 05, 2016, 04:01:36 PM »
Rate   A5 : 9.63%

Due Date
Completion Date
Payment
Amount
Principal Portion
of Payment
Interest Portion
of Payment
Principal Balance
Late Fees
Investor Fees
Payment Status
8/7/12   8/13/12   \$0.18   \$0.16   \$0.02   \$0.00   \$0.00   (\$0.01)   Completed - In Grace Period
7/7/12   7/13/12   \$1.60   \$1.59   \$0.01   \$0.16   \$0.00   (\$0.02)   Completed - In Grace Period
6/7/12   6/13/12   \$1.60   \$1.57   \$0.03   \$1.75   \$0.00   (\$0.02)   Completed - In Grace Period
5/7/12   5/11/12   \$1.60   \$1.56   \$0.04   \$3.32   \$0.00   (\$0.02)   Completed - In Grace Period

Interesting! Looks like a duck, walks like a duck, ....
Also it's not a 5.xx% A1 loan, but an A5 at 9.63%. The lower the interest rate the worse it gets.
« Last Edit: July 05, 2016, 04:04:04 PM by Rob L »