Legal Definitions - contract loan

A contract loan, also known as an add-on loan, is a type of loan where the total interest due for the entire duration of the loan is calculated upfront based on the original principal amount. This total interest is then "added on" to the principal, and the combined sum is divided into equal installments. Unlike most modern loans where interest is calculated on the *remaining* principal balance, with a contract loan, the interest portion of each payment remains constant throughout the loan's life, even as the principal balance decreases. This method can result in a higher effective interest rate compared to a simple interest loan with the same stated rate.

• Example 1: Appliance Store Financing

  Imagine a consumer purchasing a new washing machine for $800. The appliance store offers financing through a contract loan at a 15% annual interest rate over 18 months. The store calculates the total interest upfront: $800 (principal) * 15% (annual rate) * 1.5 years (18 months) = $180. This $180 is added to the $800 principal, making the total repayment amount $980. This sum is then divided into 18 equal monthly payments of approximately $54.44. Even after the consumer has paid down half of the principal, the interest portion of their monthly payment remains the same as it was in the first month, because the total interest was fixed at the beginning based on the original $800.

• Example 2: Small Personal Loan from a Finance Company

  A borrower needs a quick $1,500 personal loan for 12 months from a specialized finance company. The company structures it as a contract loan with a 20% add-on interest rate. The total interest is calculated immediately: $1,500 (principal) * 20% (annual rate) * 1 year = $300. The borrower is then obligated to repay $1,500 + $300 = $1,800 over 12 months, resulting in monthly payments of $150. This demonstrates a contract loan because the $300 interest is fixed at the outset on the full $1,500, and the borrower pays a portion of that fixed interest every month, regardless of how much principal they have already repaid.

• Example 3: Used Car Dealership Financing

  A customer buys a used car for $5,000 and finances it through the dealership with a 2-year contract loan at a 10% annual add-on interest rate. The dealership calculates the total interest for the entire loan term: $5,000 (principal) * 10% (annual rate) * 2 years = $1,000. This $1,000 is added to the principal, so the customer owes a total of $6,000, payable in 24 monthly installments of $250. This is a contract loan because the interest amount of $1,000 is determined at the very beginning based on the original $5,000, and that fixed interest is spread across all payments, rather than the interest being recalculated each month on the decreasing principal balance.