A surprise calculation: Prosper.com vs. ING

June 21st, 2006 | by mbhunter |

After reading and thinking about Prosper.com I decided to sign on as a lender and try it out with a small amount of money.

My ING account makes 4.25% (as of today) and ING CDs go up to a percent higher. I initially guessed that I’d want to get at least 8% return on any loans to compensate for my risk (even with a AA-rated borrower).

Then I ran some calculations for the effective return in each case. To my surprise, a three-year loan at 8% with no prepayment actually does worse than a 4.25% savings account!

Here are the numbers side by side ($100 loan on Prosper at 8% on the left, and $100 4.25% savings account on the right):

paymt # princ int tot princ tot int balance tot rtn% – paymt #
 princ int tot rtn%
01 2.46 0.67 02.46 00.67 97.54 00.67 – 01 100.00 0.35 00.35
02 2.48 0.65 04.94 01.32 95.06 01.32 – 02 100.35 0.36 00.71
03 2.50 0.63 07.44 01.95 92.56 01.95 – 03 100.71 0.36 01.07
04 2.51 0.62 09.95 02.57 90.05 02.57 – 04 101.07 0.36 01.42
05 2.53 0.60 12.48 03.17 87.52 03.17 – 05 101.42 0.36 01.78
06 2.55 0.58 15.03 03.75 84.97 03.75 – 06 101.78 0.36 02.14
07 2.56 0.57 17.59 04.32 82.41 04.32 – 07 102.14 0.36 02.51
08 2.58 0.55 20.17 04.87 79.83 04.87 – 08 102.51 0.36 02.87
09 2.60 0.53 22.77 05.40 77.23 05.40 – 09 102.87 0.36 03.23
10 2.62 0.51 25.39 05.91 74.61 05.91 – 10 103.23 0.37 03.60
11 2.63 0.50 28.02 06.41 71.98 06.41 – 11 103.60 0.37 03.97
12 2.65 0.48 30.67 06.89 69.33 06.89 – 12 103.97 0.37 04.33
13 2.67 0.46 33.34 07.35 66.66 07.35 – 13 104.33 0.37 04.70
14 2.69 0.44 36.03 07.79 63.97 07.79 – 14 104.70 0.37 05.07
15 2.70 0.43 38.73 08.22 61.27 08.22 – 15 105.07 0.37 05.45
16 2.72 0.41 41.45 08.63 58.55 08.63 – 16 105.45 0.37 05.82
17 2.74 0.39 44.19 09.02 55.81 09.02 – 17 105.82 0.37 06.19
18 2.76 0.37 46.95 09.39 53.05 09.39 – 18 106.19 0.38 06.57
19 2.78 0.35 49.73 09.74 50.27 09.74 – 19 106.57 0.38 06.95
20 2.79 0.34 52.52 10.08 47.48 10.08 – 20 106.95 0.38 07.33
21 2.81 0.32 55.33 10.40 44.67 10.40 – 21 107.33 0.38 07.71
22 2.83 0.30 58.16 10.70 41.84 10.70 – 22 107.71 0.38 08.09
23 2.85 0.28 61.01 10.98 38.99 10.98 – 23 108.09 0.38 08.47
24 2.87 0.26 63.88 11.24 36.12 11.24 – 24 108.47 0.38 08.86
25 2.89 0.24 66.77 11.48 33.23 11.48 – 25 108.86 0.39 09.24
26 2.91 0.22 69.68 11.70 30.32 11.70 – 26 109.24 0.39 09.63
27 2.93 0.20 72.61 11.90 27.39 11.90 – 27 109.63 0.39 10.02
28 2.95 0.18 75.56 12.08 24.44 12.08 – 28 110.02 0.39 10.41
29 2.97 0.16 78.53 12.24 21.47 12.24 – 29 110.41 0.39 10.80
30 2.99 0.14 81.52 12.38 18.48 12.38 – 30 110.80 0.39 11.19
31 3.01 0.12 84.53 12.50 15.47 12.50 – 31 111.19 0.39 11.58
32 3.03 0.10 87.56 12.60 12.44 12.60 – 32 111.58 0.40 11.98
33 3.05 0.08 90.61 12.68 09.39 12.68 – 33 111.98 0.40 12.37
34 3.07 0.06 93.68 12.74 06.32 12.74 – 34 112.37 0.40 12.77
35 3.09 0.04 96.77 12.78 03.23 12.78 – 35 112.77 0.40 13.17
36 3.23 0.02 100.00 12.80 00.00 12.80 – 36 113.17 0.40 13.57

The Prosper.com loan at 8% wins out until month 34. Then, the 4.25% savings account beats it out.

The reason for this is the same reason why banks love long-term mortgages: Most of the interest payments are up front! As the principal is paid down, the interest payments get smaller and smaller. But this works the same for lenders on Prosper: you get close to your actual interest rate if the loan is paid off early, but less if the loan goes full-term. The total return after Payment 12 is close to 7% for the loan and about a little over 4% for the savings account.

But with the savings account, your earned interest each month increases because the principal goes up, not down. So just comparing the interest rates is not correct. You have to get a much better loan rate to beat the 4.25% savings account. Eleven or twelve percent is more like it, but these loans tend to be a bit riskier than A or AA. On average, more of these loans will go into default, so your return on principal is quickly eaten up by the lack of return of your principal! The savings account, by contrast, is insured up to $100,000.

(By the way, if you want an easy $25 bonus for setting up an ING account with an initial deposit of $250, just let me know and I’ll tell you what to do!)

Questions tagged savings at Cash Commons:

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  1. 14 Responses to “A surprise calculation: Prosper.com vs. ING”

  2. By samerwriter on Jun 21, 2006 | Reply

    It looks to me like you’re assuming that when you get payments from your borrower, you just sit on the cash.

    Of course the reasonable thing to do is to deposit those payments into your ING account. If you were to do that, the picture changes significantly.

    After 3 years, $100 in the ING account at 4.25% would be worth $113.57.

    $100 lent via prosper at 8%, and invested in ING at 4.25% as payments come in would be worth $120.09.

  3. By traineeinvestor on Jun 21, 2006 | Reply

    Apologies if I am missing something her.

    For the ING account you are compounding the interest earned so that it grows over time (I love compound returns). For the Prosper loan, does your table take into account the interest you would be able to earn on the payments you recieve back from the borrower? I would assume that the payments themselves would be reinvested somewhere (even if at a lower rate than 8%)?

    Looking at it differently:

    1.with Prosper you are earning (roughly) an annualised 8% each month on the amount of principal still outstanding that month – but you also have the amount of previously repaid principal and the amount of interest already paid on the loan which you can also invest elsewhere;

    2. with ING, you earn (roughly) an annualised 4.25% on the original principal and accumulated compound interest (a compound return) but you do not have any other money to invest elsewhere.

  4. By mbhunter on Jun 21, 2006 | Reply

    Thanks for the comments!

    I hadn’t been reinvesting any of the proceeds. I was looking only at the returns of the investments themselves.

    Samerwriter, I guess you calculated that by taking the monthly payments on the 8% loan ($3.13) and putting that into the 4.25% savings account each month? That’s certainly a way to do it. (Though your bank might start charging you for all of those ACH transactions!)

  5. By Flexo on Jun 21, 2006 | Reply

    One other tiny comment. The ING Direct account is 4.25% APY .. what you calculated is 4.25% APR. The real current interest rate for ING Direct is 4.169%, which due to their method of compounding, results in a 4.25% APY.

  6. By samerwriter on Jun 21, 2006 | Reply

    Right — the alternative is leaving that money “out of play”, which clearly is never the best solution. I’ve never used prosper, but I have to assume you can get your payments deposited directly into an interest bearing account.

  7. By Steve on Jun 21, 2006 | Reply

    Your math is off – you don’t just sit on the cash that you get paid back. At the very least, you put it into the ING account or you probably re-invest it into like-loans on Prosper, in which case the return profile is much better.

  8. By differentWriter on Jun 22, 2006 | Reply

    On a side note, does anyone have the math for this?

    If I could add $500 every month to either ING savings @ 4.25% OR pay off my 2nd HELOC mortgage @ 7.25% fixed for 3 years, what should I choose?

    It seems obvious to pay off the HELOC mortgage, but all this compounding has me confused …

  9. By mbhunter on Jun 22, 2006 | Reply

    Good question differentWriter. It deserves a response. In a new post, perhaps, but thanks for asking!

    Also thanks for the other suggestions — like the distinction between APR and APY, and the perils of leaving money out of play.

  10. By Tim MMF on Jun 23, 2006 | Reply

    That is a surprising calculation. Have you actually decided to go through with your Prosper loaning? Considering the comments you received do you plan on adjusting your strategy? Great post!

  11. By frugal on Jun 28, 2006 | Reply

    Your post shows mainly what are the disadvantages when you don’t re-invest your money. At any given time point, the interest rate from prosper.com is higher than ING. But you’re decreasing the prosper.com balance for compounding opportunity at 8% or 4.25% if re-invested at ING. That is obviously not what happens in reality. Even if you don’t do ACH, the returns will come out better at prosper.com. Just look at the last couple of months. You can easily make up the difference interests if you deposited your money into ING.
    So I think the point should be what happens if you don’t re-invest.
    8% is always better 4.25%. It’s not better only when you have part of the money earning at 8%, and part of the money earning at 0% without re-investing.

  12. By Wiseclerk on Jul 10, 2006 | Reply

    As said before your comparison is off, because the money should be reinvested (e.g. in another prosper loan at 8%) as soon as it is available again.
    8% is low. Average prosper loans are in the range around 14-15%. For details see:
    http//www.wiseclerk.com

  13. By mbhunter on Jul 10, 2006 | Reply

    Tim MMF, yes I put in a small amount. So far, so good.

    Wiseclerk, cool site!

  14. By gene on Feb 18, 2007 | Reply

    I’ve been with prosper for some time. Payments are buying three more loans each month. STAY FULLY INVESTED! I did the math early. I WILL NOT lend $ at less than 12% due to costs and risk.

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