Add-On Interest§
Add-On Interest is a method of calculating loan interest where the total interest amount for the entire loan period is added to the original principal at the beginning of the loan term. The resulting sum of the principal and interest is then divided by the number of payment periods to determine the installment payment amount.
Examples§
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Example 1:
- Loan Amount: $10,000
- Interest Rate: 10% per year
- Loan Term: 3 years
- Total Interest: $1,000 (10% of $10,000) * 3 years = $3,000
- Total Amount: $10,000 (principal) + $3,000 (interest) = $13,000
- Monthly Installment: $13,000 / 36 months = $361.11
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Example 2:
- Loan Amount: $5,000
- Interest Rate: 8% per year
- Loan Term: 2 years
- Total Interest: $400 (8% of $5,000) * 2 years = $800
- Total Amount: $5,000 (principal) + $800 (interest) = $5,800
- Monthly Installment: $5,800 / 24 months = $241.67
Frequently Asked Questions (FAQs)§
Q1: How does Add-On Interest differ from simple interest?
A1: Add-On Interest adds the entire interest for the loan period to the principal at the beginning, while simple interest calculates interest on the remaining balance after each payment.
Q2: Is Add-On Interest common in personal loans?
A2: Add-On Interest is less common in personal loans but may be used in specific installment loan products.
Q3: Why is the APR higher than the stated interest rate in Add-On Interest loans?
A3: The APR is higher because it reflects the actual cost of borrowing, including the effect of the interest being added to the principal initially and then repaid over time.
Q4: How can I determine if a loan uses Add-On Interest?
A4: Reviewing the loan agreement for details on interest calculations and comparing the stated interest rate with the disclosed APR can help determine if Add-On Interest is used.
Q5: Which loans typically use Add-On Interest?
A5: Some auto loans, personal loans, and certain types of installment loans may use Add-On Interest.
Related Terms§
- Principal: The original sum of money borrowed in a loan.
- Annual Percentage Rate (APR): The annual rate charged for borrowing, expressed as a percentage, including fees and costs for getting the loan.
- Installment Loan: A loan that is repaid with a set number of scheduled payments over time.
- Simple Interest: Interest calculated on the principal portion of the loan only.
Online References§
Suggested Books§
- Personal Finance For Dummies by Eric Tyson.
- The Only Investment Guide You’ll Ever Need by Andrew Tobias.
- Banking and Financial Institutions Law in a Nutshell by William A. Lovett.
Fundamentals of Add-On Interest: Finance Basics Quiz§
Thank you for exploring the concept of Add-On Interest and engaging with our informative quiz. Keep advancing your financial knowledge for informed decision-making!
