When one person lends money to another, the lender expects the borrower to repay the loan by an agreed-upon time. In order to compensate the lender for the borrower’s use of the lender’s money (the loan proceeds), the lender will require the borrower – at least in an arm’s length setting involving unrelated persons[i] – to pay interest on the amount borrowed.
The rate of interest charged will depend on several factors including, for example, the term of the loan, whether collateral is provided by the borrower to secure repayment of the loan (as well as the quality and liquidity of such collateral), and the overall creditworthiness of the borrower. In general, the interest rate is related to the various risk borne by the lender.
Sale with Deferred Payments
When a person sells property to another, the seller usually expects, and would certainly prefer, to receive immediate payment from the buyer of an amount equal to the fair market value of the property sold.
In some cases, however, the buyer may not have the funds for the purchase readily available, may want to invest the funds elsewhere, may not want to liquidate other investments to generate the funds, or may determine that the cost of third-party financing for the amount of the consideration owing to the seller is too expensive.
Under these circumstances, the seller may agree to accept an interest bearing and secured promissory note from the buyer pursuant to which the buyer is obligated to pay the seller the portion of the consideration that the buyer was unable (or unwilling) to pay at closing.
Alternatively, the purchase and sale agreement itself may provide for deferred payments of the purchase price.
The unpaid portion of the consideration, whether reflected in a contract for the sale or exchange of property or in promissory note may be payable as a lump sum at a designated time, or in installments pursuant to an agreed-upon schedule, or upon the happening of specified events.
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