add-on loan

Lending arrangement in which (1) the total interest over the loan's entire duration is added to the principal at the time of signing the loan documents, and (2) a fixed portion of every loan repayment installment goes towards interest payment. Since this arrangement does not take into account the reducing principal balance, it results in an actual (effective) interest rate that is much higher than the quoted interest rate. In fact, more frequent the repayment installments, the higher the effective interest rate. In the modern legal lending practice, the effective interest rate (called 'annual percentage rate' or APR) must be disclosed by the lender at the time a loan application is accepted.