2. I will "refund" the payment when paying back, therefore you will lose $0 in fees (PayPal will refund all fees)
That is not true. Paypal could be in favor of either the buyer or seller, depending on the case and facts. However, there have been cases where people accounts were hacked and unauthorized refunds were issued, which could result in paypal taking action there (you would have to contact paypal directly or go through your bank if it was taken from an account). On top of that, you cannot expect someone to give you a interest free loan either so if you were to send him interest, you could possibly dispute that as well.
Interest would be paid in BTC