## Definition

Add-on Interest is a method of calculating loan interest where the total interest for the entire loan period is calculated upfront and then added to the principal. The borrower is then required to repay the sum of principal and add-on interest over the term of the loan. This means that the borrower is paying interest on interest, unlike simple interest loans.

### Phonetic

æd – ɑːn – ɪntrəst

## Key Takeaways

1. Definition: Add-On Interest is a method of calculating loan interest where the total interest for the entire loan term is calculated up front and added to the principal amount. The sum of these two amounts (principal + total interest) is then divided over the term of the loan to determine the monthly payment. This is different from simple interest, where the interest is computed on the current outstanding balance of the loan only. 2. Cost: Loans that use add-on interest are often more costly. This is because the borrower is paying interest on the entire initial principal amount over the life of the loan, rather than on the remaining unpaid principal. Therefore, even though a borrower might be reducing the loan’s principal with each payment, they continue to pay the original interest sum calculated based on the full initial loan amount. 3. Usage: Add-On Interest is commonly used in short-term installment loans such as auto loans and personal loans. Borrowers should be aware of this and understand how it impacts their overall loan costs, especially when comparing loan offers.

## Importance

Add-On Interest is a critical concept in business and finance as it greatly influences the cost of loans and financing decisions. Unlike simple interest methods where interest is calculated based on the remaining principal, Add-On Interest is calculated at the beginning of the loan based on the original amount, which makes the total payable interest much higher. Understanding this concept allows businesses and individuals to make informed decisions when choosing between different financing options. It helps in understanding the true cost of borrowing and in estimating the amount of periodic repayments throughout the loan term, thus allowing efficient financial planning and budgeting.

## Explanation

Add-On Interest is primarily used as a method of calculating the interest to be paid back on a loan, added at the inception of the loan. The purpose of Add-On Interest is to assure a pre-calculated and constant stream of interest revenue for the lender over the life of the loan. It allows lenders to add the total interest payment to the principal loan amount upfront, and borrowers then repay the combined amount in equated installments over the term of the loan. In the context of business financing, lenders use the Add-On method when they need to ensure a specific yield from a loan, regardless of early payment by the borrower. It’s commonly used in short-term lending and for borrowers who may wish to pay off their loan ahead of schedule, such as auto loans or installment loans. In this way, even if a borrower decides to repay their loan early, the lender still receives the amount of interest they expected.

## Examples

Add-On Interest refers to a method of calculating the interest to be paid on a loan by combining the total principal amount borrowed and the total interest due into a single figure, then dividing that figure by the number of loan payments to be made.
The interest is calculated on the full original loan amount (or principal), regardless of how much has been paid off. The total interest and principal of the loan are then added together, and this sum is divided by the number of payments to be made.
How does Add-On Interest differ from simple interest?
In contrast to add-on interest where the interest is calculated on the initial amount borrowed, simple interest is calculated on the outstanding balance. Therefore, with simple interest, the interest decreases as the outstanding loan decreases.
Is Add-On Interest beneficial for the borrower?
Add-On Interest can make a loan more expensive for the borrower, as the interest is calculated on the initial loan amount, rather than the decreasing outstanding balance. This can result in a higher overall interest cost compared to other methods.
Add-On Interest might be advantageous for the lender as it guarantees a certain return regardless of how quickly the principal is repaid, making it a less risky lending option.
What types of loans typically use Add-On Interest?
Add-on interest is often found in installment loans or short-term loans. These types of loans can include personal loans, auto loans, and business loans.
How can I recognize an Add-On Interest loan?
If the interest is calculated on the full loan amount and does not decrease as you make payments, then it may be an add-on interest loan. Always ask your lender explicitly about the type of interest calculation method used before agreeing to the terms.
Can Add-On Interest rates be compared to Annual Percentage Rates (APRs)?
Yes, it’s possible to convert add-on interest rates to equivalent APRs for comparison purposes. The APR will usually be higher than the nominal rate of add-on interest because it takes into account the fact that interest is charged on the original full amount, not the declining balance.

## Related Finance Terms

Due makes it easier to retire on your terms. We give you a realistic view on exactly where you’re at financially so when you retire you know how much money you’ll get each month. Get started today.

### Due Fact-Checking Standards and Processes

To ensure we’re putting out the highest content standards, we sought out the help of certified financial experts and accredited individuals to verify our advice. We also rely on them for the most up to date information and data to make sure our in-depth research has the facts right, for today… Not yesterday. Our financial expert review board allows our readers to not only trust the information they are reading but to act on it as well. Most of our authors are CFP (Certified Financial Planners) or CRPC (Chartered Retirement Planning Counselor) certified and all have college degrees. Learn more about annuities, retirement advice and take the correct steps towards financial freedom and knowing exactly where you stand today. Learn everything about our top-notch financial expert reviews below… Learn More