Question

9. Calculating an installment loan payment using the add-on method

Calculating the loan payment on an add-on interest installment loan

Installment loans allow borrowers to repay the loan with periodic payments over time. They are more common than single–payment loans because it is easier for most people to pay a fixed amount periodically (usually monthly) than budget for paying one big amount in the future. Interest on installment loans may be computed using the simple interest method or the add-on method.

The add-on method is a widely used technique for computing interest on installment loans. With the add-on method, interest is calculated by applying the stated interest rate to the ......balance of the loan. Finance charges using the add-on method are computed using the simple interest formula:

FsFs = P x r x t

In the equation, FsFs is the finance charge for the loan. What are the other values?

P is the ... amount of the loan.

r is the stated ... rate of interest.

t is the term of the loan in     ....

You’re borrowing $10,000 for two years with a stated annual interest rate of 8%. Complete the following table. (Note: Round your answers to the nearest dollar.)

Principal	$10,000
Finance charge	$
Total payback	$

You will make monthly payments throughout the life of the loan, in this case, ....

months.

What will your monthly payments be? Round your answer to the nearest cent. ..$

Answer 1

Solution

1. With the add-on method, interest is calculated by applying the stated interest rate to the beginning balance of the loan.

2. P is the principal amount of the loan.

3. r is the stated annual rate of interest.

4. t is the term of the loan in years.

5. Finance charge Fs = P*r*t = 10,000*8%*1 = 800

6. Total payback = principal amount + finance charge = 10000 + 800 = 10800

7. You will make monthly payments throughout the life of the loan, in this case, 12 months.

8. Monthly payments:

Total payback/number of months = 10800/12 = 900