Some loans charged interest on the total amount of the loan (at origination!) until the last payment is made--effectively doubling the interest charge on a loan which charges interest on the declining balance. Car and consumer loans seem to be the ones in which this method is used. I encountered such loans, as well as loans which "started over" if a payment was late, in the 1950s in the U.S. Are they legal today and where are they likely to be found? Thanks

  • It all comes down to how the contract was written and signed. For all intents and purpose if they write it that way, you sign it, you have agreed therefore legal. There are very few cases where the practice is outright illegal. So if you provide a bit more detail on the exact scenario, I can give you a bit more information from the CPA and legal perspective. – GµårÐïåñ Nov 11 '13 at 8:02
  • Some "interest-only" loans exist, which can still be found today. These would charge the same amount of interest on a fixed amount of principal balance. No principal is paid back until the end, so the interest stays the same. – THEAO Nov 11 '13 at 9:49
  • This might be otherwise characterized as allowing the debtor to defer some of their early interest payments until the end of the loan's life - with some extra payments to the lender for the risk and time value. It may be that time value of money is more valuable to debtors, who may expect that job success and promotions will make later payments even less painful than current payments. – NL7 Mar 26 '14 at 21:30
  • PMI on a mortgage in the US is treated this way, although that is not technically interest and on most loans it is terminated before the balance is settled in full. It seems to be a helpful consideration, though, for potential home buyers who are trying to decide whether they should save up enough of a down payment to avoid it. – Wesley Marshall Mar 18 '17 at 19:28
  • A few years ago I went to a car dealer together with someone who wasn't too sure about all these financial things. £8,000 loan. 10% interest over 5 years. Total payment... I expected a bit over £10,000 but the total was £12,000. So I said "f*** you" to the car dealer and told my friend not to buy from these thieving b******s. (They were obviously breaking the law because APR which would have been close to 20% was nowhere mentioned). – gnasher729 Mar 19 '17 at 16:19

This kind of loan is quite common in personal loans issue by non bank entities. It's a great way to ensure a higher average return since regardless of early payment, the total interest remains the same. Pay day loans are also like this, as they don't really charge you interest but a fixed fee based on the amount you're borrowing.

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This answer is probably very late, however, there is at least one instance I know off where reducing balance interest reduction does not take place. I do not have first hand experience of it, and I have read it in a newspaper article (sorry, I cannot quote the article by URL as I am unable to trace it). This happens in some real estate sector (slightly low end real estate development). The scenario is that the builder (the take of the loan from bank) buys the plot of land at his/her own expense, then seeks bank loan to construct an apartment complex, with a projection that families would book flats with booking amount which will incrementally increase the builder's corpus for investing in building the apartment complex. However the deal with the bank (for the initial corpus) is quite different, they give loan with a rider, they charge an interest on the loan (full loan), till the builder repays the complete principal (even if the builder repays some part of the original principal [which no builder really does]). The reason given for this is as follows: The bank does not want any part of the principal back because while under development, the apartment requires money to be fully constructed; however when the apartment is fully constructed, there is still the question if the builder can sell all the flats at the required price, if he/she cannot, then the time risk premium has to be paid to the bank (possibility that the builder cannot sell all the flats ever), which takes the form of total interest on the loan (even if the builder has paid up part of the loan). In case of the builder defaulting, the entire apartment complex is taken over by the bank (foreclosure on developer/builder) and the rest of the unsold flats are disposed/rented by the bank.

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