Harness Money

What is add-on interest?

Add-on interest refers to a method of calculating interest on a loan or financial transaction. It is a simple interest calculation that assumes the interest is added to the principal amount upfront, and the borrower pays back the total amount in equal installments over the loan term.

Under the add-on interest method, the interest amount is determined by multiplying the loan principal by the interest rate and the loan term. The resulting interest is then added to the principal to determine the total amount to be repaid. This total amount is divided into equal installments over the loan term, and the borrower makes regular payments that include both principal and interest.

For example, let’s say a borrower takes out a $10,000 loan with a 10% interest rate for a two-year term using the add-on interest method. The interest would be calculated as follows:

Interest = Principal x Interest Rate x Loan Term

= $10,000 x 0.10 x 2

= $2,000

The total amount to be repaid would be the sum of the principal and interest:

Total Amount = Principal + Interest

= $10,000 + $2,000

= $12,000

The borrower would then make equal monthly or periodic payments over the two-year term to repay the loan. In this example, the monthly payments would be $12,000 divided by 24 months, resulting in payments of $500 per month.

It’s important to note that the add-on interest method is relatively straightforward, but it often results in higher overall interest costs compared to other methods that consider declining balances over time, such as amortization. Borrowers should carefully consider the terms and interest calculations of a loan before agreeing to the add-on interest method, as it can lead to higher costs of borrowing.