Add-On interest is a method of calculating the interest to be paid over a loan simply by adding the total principal amount borrowed and the total interest to equate a single figure and then multiplied by the number of years for repayment. In the end, the total sum is divided by the number of monthly payments to be made. Any loan that combines interest and principal into one amount sum applies add-on interest.
When a loan payment is calculated with the add-on interest method, it is relatively more expensive for the borrower compared to the traditional simple interest calculation. This is rarely obtainable in consumer loans. Most loans calculate payment by the simple interest which is based on the amount of principal that is owed after each payment is made. You can find the add-one interest loans in short-term installment loans and in loans to subprime borrowers.
WHAT YOU SHOULD KNOW
- There are just a few loans that calculate the payment using. The add-on interest loan method. And they are typically short-term installment loans and loans made to subprime borrowers.
- Common loans are simple interest loans because the interest is dependent. On the principal amount owed after successive monthly payment is made.
- To calculate add-on interest loans. The principal and interest are calculated into one amount owned. Typically pay off in equal installments.
- This method causes a higher cost to the borrower.
- Add-one loans are calculated in the short-term installment. Loans and for loans made to subprime borrowers.
Unlike add-on interest loans, simple interest loans calculate charges. Based on the amount of principal that is owed after each payment is made. However, the payment may be similar to month-to-month. Causing the principal paid to increase over time while the interest paid decreases.
The earlier the simple interest loan is paid off. It attracts and causes the number of interest payments that would have been added to the future months to be total zero.
But in an add-on interest loan, the amount owed is calculated as the total of the principal borrowed in addition to the annual state interest rate, multiplied by the number of years the loan is fully repaid. After that, the total owed will be divided by the number of months of payments. Then will the monthly payment value be determined? This makes the interest owed each month throughout the life of the loan maintain the same value. The interest owed is high and will remain the same throughout the life of the loan even if the borrower pays off early.
A typical example of add-on interest
If a borrower applies and obtains a $45,000 loan on an 8% add-on interest rate to be paid over 4 years, here is the outcome simplified.
- The amount of the principal to be paid each month will be $937.5. That is ($45,000 / 48 Months (in 4 years).
- The amount of interest owed each month would be $300. That is ($45,000 x 0.08 / 12).
- The borrower on add-on is required to make payments of 1,237.5 each month ($937.5 + $300).
- The total interest paid would be 14,400 (45,000 x 0.08 x 4).