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Add individual calculated

hey thanks for joining me for this video in our personal finance series and we're gonna be talking specifically about consumer interest and interest on consumer loans so in this video we're gonna start with the simplest method for calculating interest and that's what we call the add-on method now the add-on method gets its name because what we do is we simply add the interest onto the principal now this sounds fairly obvious but there are several different ways of calculating interest on a consumer loan now we're going to go through how to calculate interest using the add-on method and then we'll talk about some of the particulars related to the frequency to which this method is used with regards to consumer loans in general so let's start real quick with just the equation for the add-on method so the equation to calculate interest which I'm going to abbreviate simply as I is P which represents our principle R which is our interest rate and T which is time which is commonly expressed in the number of years on the left hand side here I'll go ahead and put a little bit of a legend so you know exactly what we're going to be using each of these letters for so let's walk through a calculation for this so you can see how to use the formula it's pretty simple as you can imagine but let's go through it just to be thorough so the let's say that we are we're getting a loan in the principal amount for the loan is gonna be $5,000 the next thing we need to know is the interest rate on this particular loan now let's just say that we're gonna be paying 8% on this particular loan and so we're going to convert that to a decimal which is point zero eight it's really important that you do that because if you don't you're gonna get a huge number for what you would owe in interest which is going to be unrealistic and let's say this loan is going to be carried out for three years now all we simply need to do is to multiply each of these numbers together so what I would recommend that you do is go ahead and pause the video and perform the calculations on your own and then you can go ahead and resume and just make sure that you got correct answer which I'm sure you did now if you were to multiply 5000 by point zero eight or eight percent you would get four hundred dollars and multiplied over the three years over the three-year period we would have an interest of one thousand two hundred dollars now in order to calculate our actual payments what we need to do and why this is referred to as the add-on method is we're going to be taking the interest and we're going to actually add it on to the principal to figure out what our loan amount would be so very simply we would take the five thousand and we would add it to twelve hundred which would give us six thousand two hundred dollars so this would be the amount that we would owe over the three years now we can then use this to calculate our monthly payment so we know that there are twelve months in a year so in three years they're going to be 36 months so if we take the total amount we're gonna open cippolini which is the six thousand two hundred and we divide that number by 36 we can get to the amount or our actual monthly payment over the course of these thirty-six months that will get us to one hundred and seventy two dollars and 22 cents this becomes our monthly payment assuming this method now I'm sure you can realize pretty quickly that this is a very easy method to calculate interest for but I do want to provide a little bit of information regarding the frequency to which this is used so the add-on method is not a very common method of calculating interest and the reason for that is it actually doesn't really work to the benefit of the borrower so in this case the person that's taking out the loan because what happens is the principal that I'm paying is equally divided over that period of time so I'm paying it at the same rate but I don't receive any benefit for paying for making my payments my interest payment just don't drop subsequently after that so this is substantially more expensive for the borrower or the person that's actually taking out of a loan because of the fact that the interest is equally applied Oh for the entire loan so from the start of the loan if over here this is supposed to represent interest and on this axis we show time the interest payment stays the same now typically on most loans if you're making payments and your principal is decreasing then that of course impacts the amount of interest that you pay so over time your interest payments would look more like this so as a result you simply don't get a very significant benefit to using this method and it's really why it's kind of confined to only subprime type consumer loans and in very rare cases and so while this is a very simple method to use it's not one that's very common that we see in consumer lending simply because of the fact that the interest is applied blanketly for the entire duration of the loan as opposed to on a declining basis or tied to how much there is in principle now that we've determined our monthly payment using the add-on method and ultimately how much interest we're going to pay over the life of the phone which is the $1200 we can work and calculate our annual percentage rate based upon all that information so the first thing I'm going to give you is the equation for calculating an annual percentage rate and I apologize in advance it is a little bit lengthy but stay with me and we'll go through how to perform all of the calculations and what each of the actual variables means so first we're gonna start with APR and that's what we're trying to solve for and in this equation Apr lie multiplied by 95 times P plus 9 multiplied by what we call F and we divide that by 12 multiplied by P and then multiplied by P plus 1 multiplied by 4 D plus F now at this point this looks like a gigantic mess and makes absolutely no sense so let's go through and talk about what each of the variables refers to and then we can solve now the first one we're gonna talk through is APR we know that APR stands for what we call the annual percentage rate the way you want to think about APR is this is the actual cost of the borrowed money so this is what we're gonna be paying an interest each year based upon the factors that are presented here now now just previously we talked about how the interest rate we're using is the 8% but because of the fact that the interest continues over the full life with a loan that impacts what we actually pay an interest total so that all our APR is actually going to be different from that 8% we used to calculate interest via the add-on method so continuing with kind of our run through all of the different variables verson we have is APR which we know is annual percentage rate the next one we have is y now Y is gonna represent the number of payments in a year so for us this number is always gonna be 12 because we're breaking the payments down on a monthly basis the next variable is the letter F and the letter F represents the finance charges in dollars this essentially represents what we've paid an interest over the full life of the loan the next variable is D D stands for debt or in our case represents the actual amount that we are borrowing and lastly we have the letter P P represents the total number of payments that are scheduled now it's easy to confuse P with Y so Y of course is the number of payments within a year P we're talking about the total number of payments regardless of how often we're making them so this would be 36 for us since we have a three year loan we're making 12 payments in equal amounts over those three years well now that we've kind of identified all the different variables let's start filling in what we know and then we can go through the process of doing the calculations if you feel pretty confident at this point you're welcome to pause the video perform the calculations on your own pick back up and then you can kind of check your work completely up to you so for the first we're going to fill in Y so this is the number of payments that we're gonna have in years so why for us rep is 12 and we're going to multiply that by 95 times P P is the total number of payments that are scheduled so this is gonna be 36 and we're gonna add nine to that variable just to keep things fair with order of operations I'm gonna add an extra set of parentheses and we're gonna multiply that by F F is of course the interest that we're gonna pay over the life of the loan and this is 1200 so we've successfully successfully completed the numerator section of the equation now let's work on the bottom half so 12 x P again P is going to be 36 and then we're gonna take P plus 1 so this is 36 plus 1 which would get us 37 x 4 times D now D again is the amount of debt so we're taking 4 multiplying it by 5,000 which is the amount of money what worth drawing is alone and we multiply that last piece or added I should say to F which is going to be 1200 so up to this point this is what your equation should look like so again just to kind of review we have taken the number of payments in a year or of course going to multiply that by the result of 95 by our total amount of payments scheduled 36 adding that to 9 multiplying by 1200 and then on the bottom half of the equation multiplying 12 by 36 multiplying the result of that by 36 plus 1 or 37 and then on the latter portion 4 times 5,000 and then adding our full interest to that amount so in the next section here we're now going to go through and we're gonna perform some of the calculations so I have these previously prepared again if you want to on your own you're welcome to pause the video do the calculations on your own be careful for the order of operations and so when you are doing you know certain things like 4 times D plus make sure that you multiply four times the debt which is five thousand and then add it to F don't take you know five thousand plus F and then multiply it by four you mean you want to make sure and follow the sequence so you don't get tripped up at any point now I'm gonna go ahead and fill in what I've calculated based upon the information present so I've got twelve x three thousand four hundred and twenty nine x 1200 now this is the numerator portion of the equation and on the denominator we have four hundred and thirty-two x thirty-seven that one was easy and multiplied by twenty one thousand two hundred now taking a step further if we go one more layer on the top and if we multiply 12 by three thousand four hundred twenty nine by twelve hundred you should receive forty nine million three hundred and seventy seven thousand six hundred now in the bottom portion same thing we're gonna multiply four hundred and thirty-two by thirty seven by twenty one thousand two hundred so this we are gonna get a pretty large number here and that number is three hundred and eighty eight million eight hundred and sixty thousand eight hundred now at this point we simply have to divide and we get the correct answer so if you divide those taken to four decimal places you would get point one two six nine or if you want to convert it to a percentage which makes it easier you round that to twelve point seven percent so just to kind of review based upon us having a five thousand dollar loan taking out an eight percent interest over three years using the add-on method we would pay an effective interest rate or APR of twelve point seven percent so that's helpful if you're ever taking out a consumer loan via the add-on method again it's very rare but in the event that you are you want to be able to determine what's the APR what's the interest rate and this gives you the ability to compare that particular loan product with maybe others that you have because communicating things in Apr is very common in consumer lending language so if you were to have a credit card for example there's probably an APR for that credit card if you were to go to a bank they would quote you in APR for a particular loan so it makes it easier to compare different loan products if you can convert them into APR which we did below so hopefully that was helpful if you have any questions feel free host below and thanks for watching thanks for checking out this video if you learned something or enjoyed it please like and share and of course subscribe so you can get updates on additional content in the future you