What is add-on interest?
Add-on interest is a type of interest that is calculated toward the beginning of a loan. It is then applied to the principal, or amount borrowed. This form for interest guarantees that all interest is repaid even assuming the borrower pays off the loan sooner than the expected due date.
More profound definition
Add-on interest is a calculation method utilized while getting a mortgage or loan. In this method, the interest payable on the loan is calculated toward the beginning of the loan. Once the interest is calculated, it is then added to the principal. At the point when the borrower pays off the loan, he is paying off both the interest and principal.
A few financial institutions favor add-on interest rather than conventional interest since, supposing that the borrower pays her loan off early the bank will in any case get its full interest payment. With add-on interest calculated in prior to when the payments start, the borrower must pay all of the interest as though the loan had been carried to its full-term length.
It isn't common for this type of interest to be utilized in consumer loans, however it can happen. By and large, this type of financing is done between financial institutions or for business loans.
Add-on interest model
Ramin gets a loan for $1,000, and that loan is due to be paid in two years with an interest rate of 9 percent. With add-on interest, the principal is calculated by duplicating $1,000 by 9 percent and adding the amount back to $1,000, making his total principal $1,180. Ramin will pay $590 every year.
- Add-on interest loans are normally utilized with short-term installment loans and for loans made to subprime borrowers.
- The outcome is a substantially higher cost to the borrower.
- Add-on interest loans consolidate principal and interest into one amount owed, to be paid off in equivalent installments.
- Most loans are simple interest loans, where the interest depends on the amount owed on the leftover principal after every monthly payment is made.