Question

Pick one of the four loan repayment options and briefly discuss the benefits and detriments of that option. Please vary your answers so that all four options are discussed. 1. Bullet loan 2. Balloon loan 3. Equal principle payment 4. Equal payment

Answer 1

Benefits and Detriments
Bullet Loan: It requires a lump sum amount to be paid at the end of loan. The interest rates of such loan are higher However since the bulk payment is to be done at the end of ,maturity so the borrower can manage his cash flows only interest payments are to be made during the period of loan. Usually projects with large gestation period like building projects etc. can avail this. Since only after the sale of building a builder will receive cash flow so bullet loans are suitable for them

2. Balloon Loan: Balloon loans are not amortised completely at the end of the period and hence remaining principal is paid at the end of the term.
The advantage includes access to flexible interest rates. Usually a single interest rate is on offer for 5 to 7 years after which the borrower can opt for refinancing at favourable interest rate.
However after the term of balloon payment, if the interest rates go up then the borrower will lose. If the banks refuse to refinance the loan then the borrower has to sell the project to repay or they will default.

3. Equal Principle payment:
In this type of loan fixed equal principal is paid through the loan period.
The interest component keeps on decreasing as the loan period increases and the loan repayment is not fixed.
This is not suitable for a project whose cash flows occur after few years. Only a person whose cash flows are regular can avail this loan ,there will be chance of default in long duration projects the cash flow are generated after a certain fixed period o in housing project the cash flow is generated ate the end of project.

4. Equal Payment: In this type of loan equal payments are given to the banks over the period of loan. The interest component initially is higher as compared to later years and the principal component is higher in later years.
The interest rates can be fixed or fluctuating in this case based upon the choice of borrower. Salaried people or people with fixed regular income are at advantage in availing this type of loan.
People or projects with irregular cash flows will have issues in paying in fixed intervals and there may be chance of default.

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