INTERESTing

Nominal Interest Rate
This is what is normally called the “simple interest rate or “ interest na nakikita”. You borrow P 1,000.00 @ 3.5% monthly interest, so next month you have to pay P 1,000.00 plus P 35.00, right?
Add-on Interest
This is what is normally called the “effective interest rate” or “ interest na tumatama”.
It is computed by adding the interest payable to the full amount of loan principal. The add-on interest is added to the original principal amount, and becomes a part of the face amount of the promissory note.
When only one payment is involved, this method produces the same effective interest rate as the simple interest method. When two or more payments are to be made, however, use of the add-on interest method results in an effective rate of interest that is greater than the nominal rate.

Assume:
Loan P1,000.00
+ interest of 50.00 (assuming @ 5 % of P1,000 for one year)
Total P 1,050.00 ( half (or P525) at the end of the first half-year
(the other half at the end of the second half-year)

a) First P525.00 payment:
Principal P 500.00 ( P 1,000.00 times 5% divide by 2
interest 25.00

Balance P 500.00

Second P 525.00 Payment
Principal P 500.00
Interest 12.50 (P500.00 balance times 5% divide by 2

OVER PAYMENT NOT RETURNED = P 12.50
Actual interest = 6.7%

The fact:
Borrower does not use P1,000 for the entire year
but rather use:
P 1,000 for the first half-year and only
P 500 for the second half-year.

(from our wordpress blog)