Original Loan Balance Calculation

B

The method of calculating interest described in the question is known as the Add-on method.

In this method, the finance charges are first calculated based on the original loan amount, and then added to that amount to determine the total amount to be repaid. The interest is then calculated on this total amount, rather than on the remaining balance as it is paid down.

For example, if a borrower takes out a $10,000 loan with a 10% annual interest rate for 3 years, the finance charges would be calculated as follows:

$10,000 x 10% x 3 years = $3,000

The total amount to be repaid under the Add-on method would therefore be:

$10,000 + $3,000 = $13,000

Interest would then be calculated on the $13,000 total amount, rather than on the remaining balance as it is paid down.

This method can be more expensive for borrowers than other methods of calculating interest, as the interest is applied to the original loan balance, rather than the declining balance over time. This means that borrowers end up paying more interest overall, as they are effectively paying interest on a higher loan amount throughout the term of the loan.

It is important for financial professionals to understand the Add-on method and be able to explain it to clients, as well as to offer alternative methods of calculating interest that may be more beneficial for borrowers.