Algebra, trigonometry and investing
Geoff was an experienced investor and had a background working in credit and finance.
Geoff was curious about how peer-to-peer lending worked. He reviewed the available disclosure and signed up with a peer-to-peer lender as an investor.
The peer-to-peer lender allotted Geoff’s investment of $1000 across several small loans to its borrowers, with interest rates of between 15 – 20%.
Geoff wanted to assess his investment returns and to monitor his investments’ performance and so he reviewed his statements and put together an amortisation table of the borrowers making loan payments. Geoff entered the interest rate, the number of payments, and the loan amount in an excel spreadsheet and used the PMT function. The PMT function calculates the payment for a loan that has constant payments and a constant interest rate.
Geoff realised that his monthly interest return from the peer-to-peer lender was lower than his calculations even after accounting for fees.
Geoff knew peer-to-peer lending was new and felt that the peer-to-peer lender’s systems may not be configured correctly. Although the amounts involved were small, and he did not want to miss out on interest.
Geoff asked his peer-to-peer lender about his missing interest and was told that the peer-to-peer lender was using the secant method of calculating interest and that his investments were working as they should. Geoff wanted more transparency around the secant method and came to FSCL.
We investigated the peer-to-peer lender’s use of the secant method. The peer-to-peer lender acknowledged that the PMT function is commonly used in finance for amortising loans. However, the peer-to-peer lender preferred to use the secant method. The peer-to-peer lender had not disclosed how it calculated interest in its disclosure documents.
Secant is a method to use to approximate a value. The peer to peer lender was using the Secant method to calculate the amount of each payment for the borrower which, in turn, would calculate the return on investment payable to Geoff. The borrower’s payments were immediately credited to the loan balance, rather than being held in suspense until the next payment date. As payments were immediately credited, this immediately offset the amount of interest compounding on the loan.
Also, under the peer-to-peer lender’s terms, borrowers could make additional loan repayments at any time without penalty. Some of Geoff’s loans required the borrowers to make monthly payments, however some borrowers were repaying the loans fortnightly. The increase in the payment frequency was also impacting on Geoff’s forecasted rate of return.
In essence, repaying a loan faster meant less interest was payable by the borrower, and Geoff received a lower return, but there was less risk of the loan defaulting.
After reviewing the peer-to-peer lender’s figures, we were satisfied that it had accurately applied the secant method to calculate its interest rates for investors and the secant method was not unfair or negatively impacting investors or borrowers.
We explained to Geoff how the secant method operated and how, given the nature of pee-to-peer lending, it was a method reasonably available to the peer-to-peer lender.
Geoff was satisfied with our investigation and findings concerning the application of the secant method. Geoff accepted that there are several ways to calculate interest and as long as the method is validly applied, the peer-to-peer lender was not restricted to the PMT function.
Peer-to-peer lending is a growing and developing area of finance. Lessons learned from complaints made to us can be used to assist the peer-to-peer lender in making more detailed disclosure of its terms and to assist the investor in understanding how interest will be earned and calculated.