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Add-On Interest

Candlefocus Editor
Add-on interest loans are an alternative financing option to simple interest loans and are commonly available from lenders willing to accept a higher risk, such as those providing loans to subprime borrowers. With add-on interest loans, the interest and principal are combined into one sum owed, to be paid off in equal installments. Instead of paying interest on the amount of the principal remaining after each payment, as with a simple interest loan, all principal and interest are paid up front.

From the lender's perspective, the add-on interest loan is less risky, because the remaining amount due is known in advance. This allows the lender to secure their investment by a lump-sum payment and makes the loan easier to manage. In addition, the lender's return is vastly increased by including the interest in the total sum, meaning they earn interest on the entire loan amount rather than just the remaining principal.

So why might a borrower choose to take out an add-on interest loan? The advantage for borrowers is often the convenience and an extended repayment period. Add-on interest loans allow for payments over an extended period of time and often have lower minimum monthly payments, making them a viable option for individuals who are unable to make a large payment.

The downside is that add-on interest loans often come with higher interest rates and fees, resulting in a higher cost for borrowers. As the borrower pays for the entire loan amount up front, the lender is able to charge a higher interest rate, increase their return on the loan, and still offer a low monthly payment option.

In addition, the cost of an add-on interest loan is often not clear to the borrower. As the loan comes as a lump sum payment, the interest portion of the payment is not shown separately, resulting in lack of transparency and a surprise when the borrower receives the bill.

At the end of the day, borrowers should consider the cost associated with the add-on interest loan and compare it to a simple interest loan and any available financing options. Borrowers should only use this type of loan if absolutely necessary and should compare offers to ensure they get the best deal for their circumstances.

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