Add-On interest is a method of calculating the interest on a loan that deviates from the conventional methods you might be accustomed to, such as simple or compound interest
Add-On Interest Explained
Add-On interest is unique in that the interest amount is calculated upfront, based on the original loan amount, and then added to that initial sum. So, unlike other methods, your interest does not accrue over the life of the loan.
To put it simply, the total interest you owe is calculated at the beginning of the loan period and is then distributed evenly across all payments.
It sounds straightforward, and it is—but that doesn’t make it inherently beneficial. While the equal payments might appeal to those who value predictability, it can end up costing the borrower more in the long run.
Why does it matter? Understanding the type of interest you’re dealing with is vital for making informed financial decisions.
Add-on interest can be deceptively expensive, especially when compared to other types of interest calculations. Borrowers often mistake the straightforward nature of the calculation for affordability, which can be a costly error.
- Upfront Calculation: One of the most distinguishing features of add-on interest is the upfront interest calculation.
- Predictability: If you value knowing exactly what your payments will be month-to-month, add-on interest provides that comfort. However, this predictability can be a double-edged sword.
- Cost: Add-on interest can be more expensive in the long run compared to other types of interest calculation methods.
An Example Of Add-On Interest
Let’s assume you take out a loan of $10,000 with an add-on interest rate of 10% for a term of one year. The total interest payable is calculated upfront as $10,000 x 0.10, which equals $1,000.
This amount is then added to your original loan, making it $11,000. If you were to make monthly payments, each would be about $916.67 ($11,000 divided by 12 months).
Contrast this with a simple interest loan of the same amount and rate. The latter could end up being cheaper because the interest accrues on the remaining balance, which decreases over time.
Is Add-On Interest the same as simple interest?
No, these are different. Simple interest accrues over time, while add-on interest is calculated upfront.
Can I pay off an Add-On Interest loan early?
Yes, but you won’t save on interest as you would with other types of loans.
Is Add-On Interest common?
It’s less common than other methods but is still used, particularly in personal loans and some types of auto loans.