Add-On Interest

What it is

Add-on interest is a loan pricing method that calculates total interest on the full principal for the entire loan term up front, adds that interest to the principal, and divides the combined amount into equal payments. Because interest is computed on the original principal for the full term (rather than on the declining balance), add-on interest loans are usually much more expensive for borrowers than loans that use simple (amortized) interest.

How it works (versus simple/amortized interest)

• Add-on interest: Interest = principal × rate × term. Total interest is added to the principal, and the sum is divided by the number of payments. Interest paid per month stays constant and does not fall if you pay the loan off early.
• Simple (amortized) interest: Interest is computed on the outstanding principal each period. Each payment includes a changing mix of principal and interest; interest portion declines over time. Paying early reduces total interest paid.

Add-on loans are uncommon for mainstream consumer lending and are most often seen in short-term installment loans or loans to subprime borrowers.

Example

Loan: $25,000 at 8% add-on interest for 4 years (48 months)

1. Annual interest = $25,000 × 0.08 = $2,000
2. Total interest = $2,000 × 4 = $8,000
3. Loan total = $25,000 + $8,000 = $33,000
4. Monthly payment = $33,000 ÷ 48 ≈ $687.50

For comparison, an amortized (simple interest) loan at 8% for $25,000 over 4 years would have a monthly payment of approximately $610.32 and total interest of about $4,295.51. The add-on loan in this example costs roughly $3,704.49 more in interest.

How to tell if you’re being charged add-on interest

• Read the loan agreement for language that interest is calculated on the original principal and added to the principal for equal payments.
• Look for phrases like “add-on interest” or an explicit formula that multiplies principal × rate × term.
• If unclear, ask the lender directly for an amortization schedule or for the APR and an explanation of how interest is computed.

Can you save by paying off an add-on loan early?

No. Because interest is calculated up front on the full principal and included in the total balance, paying the loan off early generally does not reduce the interest charged. By contrast, paying down an amortized loan early reduces the outstanding principal and therefore reduces future interest.

Recommendations

• Favor loans that use simple (amortized) interest or compare offers using APR to capture the true cost.
• Request an amortization schedule to see how payments are applied if the method is unclear.
• Shop around—especially if you have limited credit options—to avoid add-on interest structures that significantly increase cost.

Key takeaways

• Add-on interest computes total interest on the original principal for the full term and spreads that total over payments.
• It typically costs substantially more than simple (amortized) interest and offers no interest savings for early payoff.
• Read loan documents carefully and confirm the interest calculation method before agreeing to the loan.