What Is Add-On Interest?

Add-on interest is one of the more common ways that banks and lenders calculate interest. In this schema, the interest percentage is added to the principal loan and multiplied by the amount of repayments. This is used for most loans, including credit cards, property and real estate, and most appliance purchases. The payment term is usually by month, so add-on interest gives lenders a way to collect more money and causes the debtor to spend more. This loan type will usually recalculate the interest amount each payment term, and it is most effective to pay money toward the principal loan to lower the extra interest.

When a bank or lender loans out money, it expects to make a profit when the customer repays the money. This profit is realized through interest, and add-on interest is one of the most common interest calculations. The principal is constantly being inflated by the loan’s interest percentage, so this causes debtors to pay much more if there are multiple repayments, but loans with only a few repayments will actually turn out to be lower.

Add-on interest is applied to financial transactions such as those involving credit cards, bank loans, property loans and even banks lending against other banks. The interest amount, unless specifically stated on the loan agreement, also will change after each repayment period, if there are any changes to the principal. The interest rate is added to the principal for each repayment period, so this will cause the principal to inflate, which can make it difficult to pay back the loan, especially if any payments are late.

Calculating add-on interest requires knowing the principal loan amount, the interest rate and the amount of payments. The principal, or the full amount of the loan, is multiplied by the interest rate. That number is then multiplied by the total amount of repayments. Most loans are paid once a month, so the common amount of repayments would be 12 for each year.

In an add-on interest loan, the debtor is paying a substantial amount of interest if there are many repayments. To lower the overall interest, the debtor can pay more than the minimum amount, causing the principal to lower and eventually causing the total number of repayments to lower, as well. Some loans, since the lender understands this can be done, may add fees for paying a loan quicker than the loan terms allow so the lender can recoup any losses.