Definition of Add-on Interest
Add-on interest is a standard way to calculate the amount of interest a borrower will owe in addition to the principal interest. The add-on interest is an additional sum of money that is added to the principal interest and the entire sum of these two amounts is due on the maturity date. Add-on interest is also referred to as pre-calculated interest, this additional debt owed is typically paid at the start of the loan repayment.
Why is this term important?
The add-on interest is put with the principal interest, and the entire sum of the two amounts will be due upon maturity date. If a borrower has repayments that include add-on interest, they are only returning a portion of the principal and will still be charged interest on that amount. This means the add-on interest method will cost a borrower more money than other methods. The add-on interest is calculated as though no payments will be made until the loan has fully matured — meaning you will pay interest on the full amount loaned. Add-on interest is commonly used for vehicle loans and mortgage payments.
Examples of term
Say a lender provides you with a $5,000 loan with an annual interest rate of 6%. With one annual repayment in each of the following years, you must repay the full amount within five years time. The interest you will be charged to take out this loan is the total amount multiplied by the annual interest rate and by the amount of time you hold the loan.
$5,000 x 0.06 x 5 years = $1,500 of interest charges
Your annual payment made will be $1,300 for the next five years time.