LOAN REPAYMENT PLANS

A borrower may have good repaying capacity but defective repayment plan proposed by the lender would render him to become defaulter. It is, therefore, essential to chalk out well thought repayment schedules/plans. The most commonly used repayment plans for repaying the medium and long-term loans are discussed below:

i) Straight end Lumpsum repayment plan:- The entire loan is repaid on the expiry of the term but interest amount is paid every year. This plan has advantage of using existing capital where the borrower feels high marginal productivity of capital. Furthermore, this plan assumes that the good year shall balance out the bad year and at the end sufficient repaying capacity would be available to repay the entire loan. However, it happens quite often that at the end sufficient repaying capacity is not left and chances of defaulting the loan become high.

ii) Partially amortized loan repayments:- An “amortized loan” is one which is repaid in a series of payments/instalments to cover both interest and principal amount. The term “amortization” means “killing by degrees”, i.e., the repayment of principal loan in a series of instalments. The partially amortized loan involves small principal payments every year of the repayment term and remaining unpaid principal balance become due at the end as a lump sum or balloon payment. This payment term is slightly better than the earlier one as entire principal loan is not left for repayment at the end.

iii) Amortized even/level repayment plan:- Here the equal total payments are made every year i.e. a larger proportion of each succeeding principal amount/instalment and a smaller amount representing the interest. As interest payment decreases, the principal payment increases over the life of the loan to make equal total payment. This repayment plan is more suitable where income flow is constant over the entire period of asset, e.g., tractor or pump set, etc. The following equation is used to calculate the annual repayment instalment on even/level repayment basis.

P=B 1 n ךi

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Where, “P” represents the amount of annual instalment i.e., principal plus interest, “B” is the face value of the loan, “n” is the number of years for which loan has been given and “i” the annual interest rate. The term “1/ a n ךi” is read as “1 divided by a sub n at rate i” and represents the annuity that “1” will buy/purchase for “n” years with an annual interest rate “i”.

iv) Amortized decreasing repayment plan:- It involves the constant principal payment and the declining interest payment on outstanding balance. Consequently, total instalments decline in every succeeding year till the loan is not repaid. The decreasing repayment plan is appropriate when borrower is able to pay the higher initial instalments. This plan is well suited for farm machinery and equipment loan as a nominal amount of money is needed in initial years for repair and maintenance which helps the borrower to pay the heavy instalments in the beginning.

v) Graduated loan amortization plans:- It assumes lower instalments for the repayment of loan during early years as compared to conventional level/even repayment plan. When borrower’s income increases, the repayment amount also increases.

Vi) Flexible or variable repayment plan: - Since amortized repayment plans do not account for income variability overtime, the borrower may become defaulter during the draught year. In variable repayment plan, the higher amounts are repaid in good years while small or no repayment is made in bad years. It is a flexible repayment plan and fits well into the variable nature of farm incomes.