Add-On Interest
Add-on interest is a new math way of accounting for, or paying off, bond debt.
Add-on interest adds on the cost of interest each period to the principal of a loan so that, at the end of the period, a huge debt is owed, payable at the time the principal is owed.
You borrow a hundred grand at 6% for five years with add-on interest. Every six months, another three grand is tacked onto that hundred grand that you owe. Or rather, the new debt that you owe after six months is $103,000, on which you then pay a half year's interest of that 6%, or 3%, on $103,000. And the compounding continues to get uglier.
Think of it as the debtor's version of acute zero coupon bond.
Related or Semi-related Video
Finance: What is Balloon Interest, or a ...198 Views
Finance a la shmoop what is balloon interest or a balloon payment. All right
people you blow and blow and blow and blow and then one day it pops. Well [Balloon with loan written on it explodes]
that's kind of what a balloon loan looks like in most cases common loans are paid [House with a sold sign]
down as they go like a home mortgage on you know your brand-new home there
Well it starts out as 400 grand payable over 30 years and then little by little
grinding away year after year after year the loan is paid down and the final [Years going by and the principal remaining reducing]
payment is like well just a few grand and you're the proud owner of a 30-year
old shack it's become one after 30 years... Well were this a balloon payment style [Picture of a wooden old house]
of loan well you might have just paid interest on that four hundred grand for
twenty nine point nine years and then that last payment would be the four
hundred grand principle you'd borrowed. Huge or as a famous real estate man once
said huge, that could be one month's interest on the four hundred grand plus [Donald Trump appears]
four hundred grand well that last balloon payment will have
popped when you've paid off your house. Well the same structure of debt lives in [Guy pops the balloon with a pin]
the world of zero coupon bonds and t-bills as well where you as an investor
buy a notional par value of say a grand, at a discount meaning you're buying that
thousand dollars at a discount... meaning you pay six hundred forty-two
bucks for a payment of a thousand dollars in six years with no payments of
interest or pay down of principal in between. That final loan payoff is the [Hot air balloons in the background]
balloon oh happy day and it isn't even your birthday [Guy in a suit dancing with balloons and confetti falling]
Up Next
What is a zero coupon bond? Zero coupon bonds are an interesting investment because they don’t pay any interest. They are only desirable because...
What is a muni bond? Muni bonds are bonds issued by the government. They are used to raise the money required to pay for government responsibilitie...
What is Bond Amortization? Bond amortization is simply the spreading out of the cost of the bond over time. Bonds have amortization schedules and t...