What is add-on interest?
It is a type of interest that is added to the principal balance of a loan or financial product. This means that the interest is calculated on the principal balance plus any unpaid interest that has been added on.
For example, let’s say you have a loan with a principal balance of $10,000 and an annual percentage rate (APR) of 10%. If the loan has add-on interest, the interest will be calculated on the original $10,000 plus any unpaid interest that has been added on. This can result in a higher overall cost of borrowing, as the borrower is required to pay interest on the interest that has been added on.
It is often used in conjunction with variable interest rate loans, where the interest rate may fluctuate over time. In these cases, the add-on interest is added to the principal balance at regular intervals, such as monthly or quarterly.
It’s important to understand the terms of any loan or financial product you are considering, including whether it has AOI, in order to fully understand the costs associated with borrowing. If you have questions about add-on interest or any other aspect of a loan or financial product, you may want to consult with a financial professional or an attorney.
Examples
Here are a few examples of situations where add-on interest may be used:
- Credit card loans: Credit card companies may use it to calculate the interest on unpaid balances. For example, if you have a credit card with a $1,000 balance and an APR of 20%, the credit card company may calculate the interest on the original $1,000 plus any unpaid interest that has been added on. This can result in a higher overall cost of borrowing.
- Mortgages: Some mortgage lenders may use it to calculate the interest on a home loan. In this case, the lender would add the unpaid interest to the principal balance of the loan at regular intervals, such as monthly or quarterly. This can result in a higher overall cost of borrowing for the homeowner.
- Auto loans: This may also be used to calculate the interest on an auto loan. In this case, the lender would add the unpaid interest to the principal balance of the loan at regular intervals, such as monthly or quarterly. As with other types of loans, this can result in a higher overall cost of borrowing for the borrower.
It’s important to carefully review the terms of any loan or financial product you are considering, including whether it has add-on interest, in order to fully understand the costs associated with borrowing.
The formula for add on interest
The formula for calculating add-on interest is:
Interest = Principal x Rate x Time
Where:
Principal is the original amount of the loan or financial product
Rate is the annual percentage rate (APR) or the interest rate on the loan or financial product
Time is the length of time over which the interest is being calculated, usually in years
For example, let’s say you have a loan with a principal balance of $10,000, an APR of 10%, and a term of 5 years. The AOI on this loan would be calculated as follows:
Interest = $10,000 x 10% x 5 years = $5,000
This means that the total cost of the loan would be $10,000 (principal) + $5,000 (interest) = $15,000.
It’s important to note that this is just a basic example and that the calculation of add-on interest can be more complex in practice, especially if the loan has a variable interest rate or if the interest is calculated at regular intervals (such as monthly or quarterly).
Add on interest vs. simple interest
Add-on interest and simple interest are two different ways of calculating the cost of borrowing.
Simple interest is calculated based on the principal balance of the loan or financial product, the interest rate, and the length of time over which the interest is being calculated. The formula for calculating simple interest is:
Interest = Principal x Rate x Time
Where:
Principal is the original amount of the loan or financial product
Rate is the annual percentage rate (APR) or the interest rate on the loan or financial product
Time is the length of time over which the interest is being calculated, usually in years
For example, let’s say you have a loan with a principal balance of $10,000, an APR of 10%, and a term of 5 years. The simple interest on this loan would be calculated as follows:
Interest = $10,000 x 10% x 5 years = $5,000
This means that the total cost of the loan would be $10,000 (principal) + $5,000 (interest) = $15,000.
AOI, on the other hand, is calculated by adding the unpaid interest to the principal balance of the loan or financial product at regular intervals, such as monthly or quarterly. This means that the interest is calculated on the principal balance plus any unpaid interest that has been added on. This can result in a higher overall cost of borrowing, as the borrower is required to pay interest on the interest that has been added on.
It’s important to understand the terms of any loan or financial product you are considering, including whether it has simple interest or add-on interest, in order to fully understand the costs associated with borrowing.
Interested in how we think about the markets?
Read more: Zen And The Art Of Investing
Watch here: Kuvera Insights: All about Quant Funds with experts
Start investing through a platform that brings goal planning and investing to your fingertips. Visit kuvera.in to discover Direct Plans and Fixed Deposits and start investing today. #MutualFundSahiHai #KuveraSabseSahiHai
