Understanding the Peer-to-Peer Lending Business, How Lending Club and Prosper Make Their Money

Traditional commercial banks make their money by borrowing money from savers and then lending it out at higher interest rates than they are paying to savers. Peer-to-peer lending companies also provide savings-like and lending opportunities, but companies in the peer-to-peer lending business generate revenue in a slightly different way.

Unlike a bank, peer-to-peer lending companies do not have any assets or deposits. They simply facilitate the transfer of money between their lenders and borrowers using peer-to-peer lending platforms. Since they can’t make money on the difference between what they lend and what they borrow at, they instead make their revenue by charging an origination fee to the borrower and a loan management fee to the investor.

For example, Lending Club charges borrowers an origination fee between 1.25% and 4.50% of the original loan amount to the borrower as a “borrower processing fee.” Lending Club doesn’t charge an application fee. Prosper.com charges an origination fee between 0.5% and 3.0% depending upon the borrower’s credit.

On the investor’s side, Prosper.com charges a 1% annual loan servicing fee. Lending Club charges investors a 1% fee on all payments made by borrowers as a “service charge.” Lending Club’s website states that “The 1% service charge impacts the lenders’ annual returns by less than 1% because it is not an annual charge.”

A good analogy to how peer-to-peer lending companies make their money is professional poker rooms. In these poker rooms, the casino doesn’t actually own any of the money that’s being gambled; instead they simply facilitate poker games and let individuals gamble their own money. Poker rooms make their money by taking a chip off of each round of play, guaranteeing the house a profit regardless of how well any individual player does.

The peer-to-peer lending business is still in its infancy. Online peer-to-peer lending didn’t exist before 2006 and companies are still refining their business models. These companies generally do have some sort of revenue, but it will take some time for these companies to develop fee structures and specific guidelines about interest rates and loan terms to ensure long term success.