Definition of complementary interests
What is complementary interest?
Premium interest is a method of calculating the interest payable on a to lend by combining the total main the amount borrowed and the total interest due in one digit, then multiplying that number by the number of years before repayment. The total is then divided by the number of monthly payments to be made. The result is a loan that combines interest and principal into one amount owed.
This method of calculating the repayment of a loan is much more expensive for the borrower than the traditional method. simple interest calculation and is rarely used in consumer loans. Most loans use simple interest, where the interest charged is based on the amount of principal owed after each payment. Interest-plus loans can sometimes be used as part of short-term installment loans and mortgage loans. risk borrowers.
Key points to remember
- Most of the loans are simple interest loans, where the interest is based on the amount owed on the principal remaining after each monthly payment.
- Additional interest loans combine principal and interest into a single amount owed, to be repaid in equal installments.
- The result is a considerably higher cost to the borrower.
- Loans with additional interest are generally used with short-term installment loans and for loans to subprime borrowers.
Understand complementary interests
In simple interest loans, where the interest charged is based on the amount of principal that is due after each payment, the payments may be the same from month to month, but this is because the principal paid increases over time while the interest paid decreases.
If the consumer prepays a loan at simple interest, the savings can be substantial. The number of interest payments that would have been attached to future monthly payments has been effectively deleted.
But in a top-up interest loan, the amount owed is calculated in advance as the total of the principal borrowed plus annual interest at the stated rate, multiplied by the number of years until the loan is fully repaid. This total due is then divided by the number of months of payments due to arrive at a monthly payment figure.
This means that the interest owed each month remains constant throughout the life of the loan. The interest owed is much higher, and even if the borrower prepays the loan, the interest charged will be the same.
Example of additional interest
Suppose a borrower gets a loan of $ 25,000 at an additional interest rate of 8% which must be repaid over four years.
- The principal amount payable each month would be $ 520.83 ($ 25,000 / 48 months).
- The amount of interest owed each month would be $ 166.67 ($ 25,000 x 0.08 / 12).
- The borrower would be required to make payments of $ 687.50 each month ($ 520.83 + $ 166.67).
- The total interest paid would be $ 8,000 ($ 25,000 x 0.08 x 4).
Using a simple interest loan payment calculator, the same borrower with the same 8% interest rate on a $ 25,000 four-year loan would have required monthly payments of $ 610.32. The total interest owed would be $ 3,586.62.
The borrower would pay $ 4,413.38 more for the top-up interest loan than the simple interest loan, that is, if they did not repay the loan sooner, which would reduce the loan even more. total interest.
When looking for consumer credit, especially if you have bad credit, read the fine print carefully to determine if the lender is charging you additional interest. If so, keep looking until you find a simple interest loan.