Personal Finance & Money Asked by Pjotter on March 31, 2021
Say I have a loan of 3,000,000 with a 5-year tenor and a repayment profile of 10 years such that 300,000 will be paid back each year. Does a 5-year tenor mean that I will start paying 300k yearly after 5 years have passed? Or does this mean I pay 300k each year until maturity, and then have to pay the outstanding amount back at maturity?
It's not completely clear from the information that's given, but my guess is that your payment is calculated based on an amortization of 10 years (more then 300k per year depending on the interest rate) but that the remainder of the loan is due after 5 years. You will owe more than half of the loan since amortized payments are designed such that less principal is paid in the early part of the loan since the interest is calculated based on the remaining principal, which goes down as you make payments. This final payment is called a balloon payment and is not uncommon. Most often a new loan is taken out to cover the balloon payment.
The risk you face is if interest rates rise significantly over the next 5 years you could be faced with a much higher payment when you refinance (presuming you can't pay off the remaining principal at maturity). At today's low interest rates, a safer loan would be a fixed rate loan for as short of a tenor as you can afford.
If this is a car loan I would avoid it like the plague. You'll be underwater for the entire life of the loan since cars drop in value. In 5 years you'll be stuck with a balloon payment for much more than the car is worth. It's not as bad for a mortgage if you can make a significant sown payment, but it's still risky.
Correct answer by D Stanley on March 31, 2021
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