Before digging deep into what the term actually means, you must know what the meaning of interest is. In economics or finance, interest is payment from a deposit-taking financial institution or a borrower to the depositor or the lender about the amount as a repayment of the principal sum but at a special rate. It is known as the distinct fee which the borrower needs to pay the lender or the third party.
Whereas, Add-on-Interest is the type of interest that is calculated at the start of the loan. Later it is applied to the principal or the borrowed amount. This form of interest makes sure that all the interest is repaid even when the borrower pays off the loan earlier than the expected due date.
Now to briefly discuss the Add-on-Interest, it is a method of calculating the interest to be paid on a loan, which combines the total principal amount borrowed and real interest into one figure and then multiplying it by the number of the years to repayment. The total is then divided by the monthly payment number. The result is a loan that combines principal and interest into one amount due.
The method of calculating the payment on the loan is more valuable for the borrower than the traditional simple interest calculation and is rarely used for the consumer loans. Most loans use simple interest. Add-on-interest frequently uses short-term instalment loans and in loans to subprime borrowers.
Add-on-interest is a type of interest that is figured into the total cost of the loan over its whole life. And add-on-interest is compared to the simple interest loan.
For example, suppose a person needs to borrow a $25,000 as a loan at an 8% add-on interest rate, which needs to be repaid over four years. The number of principals that needs to be paid every month would be $520.83 ($25,000/48 months). The amount of interest owed each month would be $166.67 ($25,000×0.08/12). Then the borrower needs to make $687.50 monthly payments ($520.83+$166.67). The total interest paid would be $8000 ($25,000×0.08×4).
If you use a simple interest loan payment calculator, the same borrower with the same 8% interest rate on the $25,000 loan over four years will give needed monthly payments of $610.32 where the total interest due would be $3,586.62.
And then, the borrower needs to pay $4,413.38 more for the add-on interest loan, which must be compared to the simple interest loan if the borrower did not pay the loan early, which is reduced into the total interest.
