Business Definition for: add-on interest
add-on interest
finance charges computed by adding the interest payable to the full amount of loan principal. The add-on interest is added to the original principal amount, and becomes a part of the face amount of the promissory note.
Computing interest due under the add-on interest method is fairly simple. The loan
principal
is divided into a number of fixed payments, and each payment is multiplied by the finance charge, to calculate the interest cost to the borrower: Add-On Interest = Principal × Rate × Number of Months in the loan/12.
See also
Rule of the 78's
,
amortization
,
simple interest
,
discount
add-on interest
interest that is added to the principal of a loan. The amount of interest for all years is computed on the original amount borrowed, so the stated rate is much lower than the
annual percentage rate (APR)
, which is required to be disclosed by federal
law.
add-on interest
interest that is added to the principal of a loan. The amount of interest for all years is computed on the original amount borrowed.
Example: Abel borrows $1,000 at 8% add-on interest for 4 years. Total interest is $320 (8% of $1,000 for 4 years). Abel will repay the $1,320 total in equal monthly installments.
Related Terms:
mathematical formula used in computing the interest rebated when a borrower pays off a loan before maturity. The Rule of 78's, also known as the Sum of the Digits, is applied mostly to consumer loans in which the finance charges were computed using the add-on interest or discounted interest method of interest calculation.
The formula for calculating rebates works as follows: add up the number of months for which payments are scheduled; in a 12-month installment loan, the total is 78. This number, divided by the number of payments to be made, equals the finance charge for that month. In the first month, the borrower has use of the whole amount borrowed, and the finance charge is 12/78 of the total interest; in the second month, it is 11/78, and so on. A $3,000 loan, paid in 15 equal installments of $225, has an interest payment of $28.13 in the first month, $26.25 in the second, and only $1.87 in the final month. Thus, under the add-on method, the finance charges in the early months are higher than later on, which means that paying off an installment loan early doesn't necessarily reduce the amount of interest the borrower would have paid. The truth in lending act, however, requires that lenders disclose how the finance charge will be computed if the debt is paid in full before maturity, so borrowers can weigh different financig alternatives before signing a loan agreement.
gradual reduction of an amount over time. Examples are amortized expenses on limited life intangible assets and deferred charges. Assets with limited life have to be written down over the period benefitted. The amortization entry is to debit amortization expense and credit the intangible asset. However, unlimited life intangibles are subject to an annual impairment test.
computations based only on the original principal. compound interest is applied to the original principal and accumulated interest. For example, $100 deposited in a savings account at 10% simple interest would yield the interest of $10 per year (10% of $100).
- difference between the face value(i.e., future value) and the present valueof a payment.
- reduction in price given for prompt payment.See also sales discount; trade discount.
- excess of the par value (face value) of a financial instrument over the price paid for it. See also bond discount.
Referring Terms:
Copyright c 2006, 2000, 1997, 1993, 1990 by Barron's Educational Series, Inc. Reprinted by arrangement with Publisher.
Copyright © 2007, 2000, 1997, 1987, by Barron's Educational Series, Inc. Reprinted by arrangement with Publisher.
Copyright © 2004, 2000, 1997, 1993, 1987, 1984 by Barron's Educational Series, Inc. Reprinted by arrangement with Publisher.
