Opinion ID: 2538609
Heading Depth: 2
Heading Rank: 1

Heading: Add-On Interest Versus Simple Interest

Text: To inform our discussion, we begin our analysis with a brief summary of how simple interest and add-on interest work when applied to installment transactions. The simple interest method requires calculating the finance charge by applying a periodic interest rate to the outstanding balance of the unpaid principal [upon] every repayment period for the term of the loan. KATHLEEN E. KEEST & ELIZABETH RENUART, NAT'L CONSUMER LAW CTR., THE COST OF CREDIT: REGULATION AND LEGAL CHALLENGES § 4.3.1.1, at 121 (2d ed.2000) (emphasis omitted). In order to arrive at a consistent monthly payment amount, complex calculations must be made to predict the interest due at each payment on the declining principal. See id. at 122-24. The end result is that, for every payment made, the accumulated finance charge for that payment period is paid first, and any remainder is subtracted from the outstanding balance of the debt. Id. at 122. Because interest is paid as it is earned, if the term of the loan is abbreviated by prepayment or other circumstances, there is rarely unearned interest that must be returned to the debtor. Id. § 5.5.1, at 182-83. Before the widespread use of computers, add-on or precomputed interest was a common method used for installment transactions because it avoided the complex calculations necessary for simple interest. Id. § 4.3.2, at 127. In computing add-on interest, the interest charges are applied to the entire principal amount for the entire term, regardless of the declining principal. Id. Further, many add-on interest rate statutes do not use the words `add-on' to describe the rates therein. They may, for example, use such terms as `$8.00 per $100 per annum' to describe an 8% add-on rate. Id. at 129. Because add-on interest is precomputed, the note or contract should contain an agreement as to how unearned interest will be rebated in the event of prepayment. Id. at 127. Moreover, most state laws governing consumer credit transactions have long required that unearned interest and other unearned charges be rebated when a precomputed contract is terminated early. Id. § 4.5.3, at 146.