Question

Take the role of either a lender or a customer and identify yourself. You are negotiating the terms of a $500,000 loan for a new piece of equipment. What type of loan (amortization style), interest rate, and term would you negotiate? Describe why you believe these terms are important and how you chose them. Get in early as duplicate answers won’t be accepted.

Answer 1

Let us take the role of a lender:

We want to earn the highest possible interest on our $500,000 within the legal rules of lending. To maximize the return on our investment (the loan is an investment from the lender's perspective) we would like to have the following characteristics:

1. The loan should be amortized with equal monthly installments without any provision of prepayments. If pre-payments are there then there should be a pre-payment penalty to compensate for the loss of interest income.

2. The interest rate should be as high as we can make the borrower accept. It should at least be higher than our own cost of capital otherwise we would suffer a loss on this loan. Moreover, it will also depend on the creditworthiness of the borrower. If the borrower does not have a very good credit score, the interest should be higher.

3. Longer-term amortized loans fetch greater interest incomes to lenders because the principal amount stays outstanding for a longer time. Thus we would want it to be a long term loan unless we have an upcoming requirement of this principal money and we want it back in short term.