What is add-on interest?
This article explains what add-on interest is.
What is Add-On Interest:
Add-on interest is a method of calculating the interest to be paid on a loan by:
1) combining the total principal amount borrowed and the total interest due into a single figure then
2) multiplying that figure by the number of years to repayment. The total is then
3) divided by the number of monthly payments to be made. The result is a loan that combines interest and principal into one amount due.
Note: The added interest must also be repaid, even if the loan is paid off early.
Understanding Add-On Interest:
Most loans are so-called simple interest loans - that is, the interest charged is based on the amount of principal that is owed after each payment is made. The payments may be identical in size from month to month, but that is because the principal paid increases over time while the interest paid decreases.
If the consumer pays off a simple interest loan early, the savings can be substantial. The number of interest payments that would have been attached to future monthly payments has been effectively erased.
But in an add-on interest loan, the amount owed is calculated up front as a total of the principal borrowed plus annual interest at the stated rate, multiplied by the number of years until the loan is fully repaid. That total owed is then divided by the number of months of payments due in order to arrive at a monthly payment figure.
This means that the interest owed each month remains constant throughout the life of the loan. The interest owed is much higher and even if the borrower pays off the loan early, the interest charged will be the same.
An Example of Add-On Interest:
Say a borrower obtains a 12-months, $10,000 loan at a 10% add-on interest rate, paid monthly. The loan is funded on 8/1/2019. See the terms below:
Principal Balance: $10,000.00
Term: 12 months
Frequency: Monthly
Note Rate: 10%
Total Interest Due: $1,000.00 ($10,000.00 * 10%)
Total Loan Amount: $11,000.00
Monthly P & I: $916.67 ($11,000 / 12)
Monthly Interest: $83.33 ($1,000 / 12)
Monthly Principal: 833.33 ($10,000 / 12)
|
Payment Due |
Payment Amount |
Apply To Interest |
Apply To Principal |
Principal Balance |
|
8/1/2019 |
$10,000.00 |
|||
|
9/1/2019 |
$916.67 |
$83.33 |
$833.33 |
$9,166.67 |
|
10/1/2019 |
$916.67 |
$83.33 |
$833.33 |
$8,333,33 |
|
11/1/2019 |
$916.67 |
$83.33 |
$833.33 |
$7,500.00 |
|
12/1/2019 |
$916.67 |
$83.33 |
$833.33 |
$6,666.67 |
|
1/1/2020 |
$916.67 |
$83.33 |
$833.33 |
$5,833.33 |
|
2/1/2020 |
$916.67 |
$83.33 |
$833.33 |
$5,000.00 |
|
3/1/2020 |
$916.67 |
$83.33 |
$833.33 |
$4,166.67 |
|
4/1/2020 |
$916.67 |
$83.33 |
$833.33 |
$3,333.33 |
|
5/1/2020 |
$916.67 |
$83.33 |
$833.33 |
$2,500.00 |
|
6/1/2020 |
$916.67 |
$83.33 |
$833.33 |
$1,666.67 |
|
7/1/2020 |
$916.67 |
$83.33 |
$833.33 |
$833.33 |
|
8/1/2020 |
$916.67 |
$83.33 |
$833.33 |
$0.00 |
|
Totals |
$11,0000.00 |
$1,000.00 |
$10,000.00 |
TIP: To setup an add-on interest loan you must first select Add-On Interest in the loan’s Options tab, then enter the loan’s original balance, the closing date (funding), the maturity date, and the monthly payment amount. These fields are important because they are used when calculating the amount of periodic principal and interest. For example, the system will use the closing and maturity dates to calculate the term of the loan.