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# Add-On Interest Definition, Formula, and Cost vs. Simple Interest

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Add-On Interest: What Is It?

Adding the entire principle borrowed and the total interest due to a single number and multiplying that number by the years until payback, add-on interest determines the interest to be paid on the loan. The number of required monthly payments is then multiplied by the sum. The result is a loan where the total amount owed includes interest and principal.

It is uncommon for consumer loans to employ this technique of calculating the payment since it is much more costly for the borrower than the standard basic interest computation. Most loans employ simple interest, depending on the principal balance due after each payment. Short-term installment loans and loans to subprime borrowers both sometimes employ add-on interest loans.

Knowledge of Add-On Interest

The payments on simple interest loans, where interest is calculated based on the remaining principal balance after each payment, may be the same amount each month. However, this is only because the principal paid grows while the interest paid drops.

Consumers may save much money by paying off simple interest loans early. Future monthly payments that would have included interest payments have essentially been eliminated.

However, with an add-on interest loan, the entire amount due is determined by adding the principal borrowed and the yearly interest rate multiplied by the years until the loan is paid in full. The monthly payment amount is then calculated by dividing the total amount owing by the number of months’ worth of payments.

This indicates that the monthly interest payment will stay the same for the duration of the loan. Even if the borrower pays off the loan early, the interest charged will remain the same since the amount owing is significantly larger.

Illustration of Add-On Interest

• A borrower takes out a \$25,000 loan with a four-year repayment period and an 8% add-on interest rate.
• The monthly principal payment is \$520.83 (\$25,000 / 48 months).\
• The interest would be \$166.67 monthly (\$25,000 x 0.08 / 12).
• The monthly payment for the borrower would be \$687.50 (\$520.83 + \$166.67).
• (\$25,000 x 0.08 x 4) would be \$8,000 in total interest paid.

Using a basic interest loan payment calculator, the same borrower would have needed to make monthly payments of \$610.32 for a \$25,000 loan with a four-year term at an 8% interest rate. The total amount of interest owed is \$3,586.62.

If the borrower did not pay off the loan early, lowering the total interest even further, they would have to pay \$4,413.38 more for the add-on interest loan than the basic interest loan.

Read the small print thoroughly when looking for consumer loans, particularly if you have bad credit, to see whether the lender adds extra interest to your loan. In such a situation, keep looking till you come across a loan with simple interest.

Conclusion

• Most loans are simple interest loans, where the interest is calculated based on the balance due on the principal balance after each monthly payment.
• Loans with add-on interest combine the principle and interest into a single sum that must be repaid over time in equal payments.
• The borrower will pay a much higher price as a consequence.
• Short-term installment loans and loans to subprime borrowers both often include add-on interest loans.

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