A reader recently asked how the interest is calculated on Lending Club loans and what her return in dollars might be.

Here’s my answer:

Loans through Lending Club are amortized over 36 months to keep payments fixed.  The quoted rate is the yearly rate, so 1/12 the rate is applied to the outstanding principal each month.  To determine your return, you’ll need to calculate the monthly payment, take out the 1% payment service fee and multiple by 36 months.  I believe that estimated monthly payments are shown when you consider a loan, but if not, you can use the following formula in Microsoft Excel, Google Spreadsheets, or a similar program: =PMT(rate/12,36,-loan) where rate is the quoted rate as a decimal (13% would be 0.13) and loan is the amount that you loan.  For example, 10% interest on a $3000 loan would be represented as =PMT(0.10/12,36,-3000), which returns a monthly payment of $96.80.  Multiplying by .99 is what you would get each month after the 1% service fee is taken out.  So you would get $95.83 each month.  After 36 months, you will have received $3450.01 for a profit of $450.01.  That amount would be subject to taxes as interest income, so your after tax profit would be $450.01 x (1-0.28) = $324.01.  The 0.28 in the formula assumes the 28% tax bracket, so substitute your actual tax bracket there if its something different.

Putting the entire calculation into a single formula:

profit after taxes = loan - PMT(rate/12,36,-loan)*.99*36*(1-.28).

Remember that’s the maximum profit and any defaults would reduce the amount.

A $3000 loan was used for this example, but funding large amounts to a single loan adds much more risk.  A better way to think of this example is a $3000 portfolio (spread across 120 loans of $25 each) with an average return of 10%.

This entire post assumes that you make your initial investment and then let the payments you receive just sit there, or withdraw them.  In reality, you would probably reinvest some ( or all) of the payments you receive each month, which could result in a much higher profit.  Just reinvesting the principal received, for example, would raise your annual return to the quoted interest rate.