What Is Add-On Interest?

Add-on interest is a method of calculating the interest to be paid on a loan by combining the total principal amount borrowed and the total interest due into a single figure, then multiplying that figure by the number of years to repayment. The total is then divided by the number of monthly payments to be made. The result is a loan that combines interest and principal into one amount due.

This method of calculating the payment on a loan is substantially more expensive for the borrower than the traditional simple interest calculation and is rarely used in consumer loans. Most loans use simple interest, where the interest charged is based on the amount of principal that is owed after each payment is made. Add-on interest loans may occasionally be used in short-term installment loans and in loans to subprime borrowers.

Understanding Add-On Interest

In simple interest loans, where the interest charged is based on the amount of principal that is owed after each payment is made, the payments may be identical in size from month to month, but that is because the principal paid increases over time while the interest paid decreases.

If the consumer pays off a simple interest loan early, the savings can be substantial. The number of interest payments that would have been attached to future monthly payments has been effectively erased.

But in an add-on interest loan, the amount owed is calculated upfront as a total of the principal borrowed plus annual interest at the stated rate, multiplied by the number of years until the loan is fully repaid. That total owed is then divided by the number of months of payments due in order to arrive at a monthly payment figure.

This means that the interest owed each month remains constant throughout the life of the loan. The interest owed is much higher, and, even if the borrower pays off the loan early, the interest charged will be the same.

Example of Add-On Interest

Say a borrower obtains a $25,000 loan at an 8% add-on interest rate that is to be repaid over four years.

• The amount of principal to be paid each month would be $520.83 ($25,000 / 48 months).
• The amount of interest owed each month would be $166.67 ($25,000 x 0.08 / 12).
• The borrower would be required to make payments of $687.50 each month ($520.83 + $166.67).
• The total interest paid would be $8,000 ($25,000 x 0.08 x 4).

Using a simple interest loan payment calculator, the same borrower with the same 8% interest rate on a $25,000 loan over four years would have required monthly payments of $610.32. The total interest due would be $3,586.62.

The borrower would pay $4,413.38 more for the add-on interest loan compared to the simple interest loan, that is, if the borrower did not pay off the loan early, reducing the total interest even more.

When researching a consumer loan, especially if you have poor credit, read the fine print carefully to determine whether the lender is charging you add-on interest. If that is the case, continue searching until you find a loan that charges simple interest.

What Is Average Cost Method?

Average cost method assigns a cost to inventory items based on the total cost of goods purchased or produced in a period divided by the total number of items purchased or produced. Average cost method is also known as weighted-average method.

Understanding the Average Cost Method

Businesses that sell products to customers have to deal with inventory, which is either bought from a separate manufacturer or produced by the company itself. Items previously in inventory that are sold off are recorded on a company’s income statement as cost of goods sold (COGS). COGS is an important figure for businesses, investors, and analysts as it is subtracted from sales revenue to determine gross margin on the income statement. To calculate the total cost of goods sold to consumers during a period, different companies use one of three inventory cost methods:

Average cost method uses a simple average of all similar items in inventory, regardless of purchase date, followed by a count of final inventory items at the end of an accounting period. Multiplying the average cost per item by the final inventory count gives the company a figure for the cost of goods available for sale at that point. The same average cost is also applied to the number of items sold in the previous accounting period to determine the COGS.

Example of Average Cost Method

For example, consider the following inventory ledger for Sam’s Electronics:

What Is the 11th District Cost of Funds Index?

The 11th District Cost of Funds Index (COFI) is a monthly weighted average of the interest rates paid on checking and savings accounts offered by financial institutions operating in Arizona, California, and Nevada. It is one of many indices used by mortgage lenders to adjust the interest rate on adjustable rate mortgages (ARM) and was launched in 1981. With an ARM mortgage, the interest rate on a mortgage moves up and down along with some standard interest rate chosen by the lender, and COFI is one of the most popular indices in the western states.

Published on the last day of each month, the COFI represents the cost of funds for western savings institutions that are members of Federal Home Loan Bank of San Francisco, a self-regulatory agency, and satisfy the Bank’s criteria for inclusion in the index.

Understanding the 11th District COFI

The 11th District Cost of Funds Index (COFI) is computed using several different factors, with interest paid on savings accounts comprising the largest weighting in the average. As a result, the index tends to have low volatility and follow market interest rate changes somewhat slowly; it is generally regarded as a two-month lagging indicator of market interest rates. The interest rate on a mortgage will not match the COFI, rather the ARM rate is typically 2% to 3% higher than COFI, depending on the borrower’s credit history, the size and terms of the loan, the ability of the borrower to negotiate with the bank and many other factors.

Because it is computed using data from three western states, the COFI is primarily used in the western U.S., while the 1-year Treasury index is the measure of choice in the eastern region. On April 30, the Federal Home Loan Bank of San Francisco announced the COFI for March 2018 of 0.814%, slightly lower than February.

What Is an Appraisal?

An appraisal is a valuation of property, such as real estate, a business, collectible, or an antique, by the estimate of an authorized person. The authorized appraiser must have a designation from a regulatory body governing the jurisdiction of the appraiser. Appraisals are typically used for insurance and taxation purposes or to determine a possible selling price for an item or property.

Understanding Appraisals

Appraisals are used in many types of transactions, including real estate. If a home valuation, for example, comes in below the amount of the purchase price, mortgage lenders are likely to decline to fund the deal. Unless the prospective buyer is willing and able to come up with the difference between the appraised value and the lender’s financing offer, the transaction will not go forward.

The appraiser can use any number of valuation methods to determine the appropriate value of an item or property, including comparing the current market value of similar properties or objects.

Appraisals are also done for tax purposes when determining the value of charitable donations for itemized deductions. Deductions can reduce your taxes owed to the IRS by deducting the value of your donation from your taxable income.

Appraisals can also be a helpful tool in resolving conflicts between heirs to an estate by establishing the value of the real estate or personal property to be divided.

Types of Appraisals

Home Appraisals

A home valuation is necessary during the process of buying and selling a home, as well as a refinance of an existing mortgage. A refinance is when a loan or mortgage is reevaluated and updated to current interest rates and new terms.

An appraisal determines the home’s value to ensure that the price reflects the home’s condition, age, location, and features such as the number of bathrooms. Also, valuations help banks and lenders avoid loaning more money to the borrower than the house is worth.

In the event of default, when the borrower can’t make the payments anymore, the bank uses the appraisal as a valuation of the home. If the home is in foreclosure, whereby the bank takes possession of the house, it must be resold to help the lender recoup any losses from making the mortgage loan.

It’s important to remember that when a bank lends for a mortgage, it gives the full amount of the home’s value to the seller on the date it’s sold. In other words, the bank is out the money and, in return, has a promise to pay, plus interest, from the borrower. As a result, the valuation is important to the lending process since it helps the bank avoid losses and protect itself against lending more than it might be able to recover if the borrower defaults.

Collectibles or Antiques

Professional appraisals can be done for many items, including collectibles, antiques, or grandma’s silver. Ideally, you’ll want multiple valuations for an item from an accredited professional. Appraisers might charge an hourly rate or a flat fee. 

A certified appraiser’s valuation will likely be fair and unbiased, whereas the local collectible shop has an incentive to offer you less for the item. Also, owners can get an idea of an item’s value by checking collectible magazines and online appraisal websites. Most websites charge a small fee, such as $10, to value an item. Of course, obtaining a value online is done through photos of the item and is not an official valuation, but it should give you an idea of what it’s worth before proceeding. If you decide to pursue an appraisal, the American Society of Appraisers has thousands of members and is a great place to begin searching for an accredited professional.

Appraisals and Insurance

Some types of insurance policies also require appraisals of goods being insured. Homeowners’ and renters’ insurance policies protect policyholders against the loss of personal property due to theft or damage. These blanket policies cover items up to a preset dollar limit. Obtaining an appraisal of the contents of a home creates an inventory of the owner’s property and establishes its value, which helps to ensure a swift settlement if a claim is filed.

When the value of specific items exceeds a homeowners policy limit, the policyholder may wish to obtain additional insurance that covers luxury items such as jewelry or collectibles, including art objects and antiques. Before issuing personal property insurance policies for high-end items, many insurance underwriters require applicants to have the object appraised. The appraisal creates a record of the item’s existence, along with its description. It also helps establish the item’s actual value.

Some insurance contracts include an appraisal clause that specifies the owner agrees to obtain an appraisal from a mutually agreeable expert in the event of a dispute between the owner and the insurance company. Neutral appraisals can speed the resolution of a settlement and keep disputes from escalating into lengthy and expensive lawsuits.

Home Appraisal Process and Cost

The home appraisal process typically begins after a buyer makes an offer on a home and that offer is accepted by the seller. The buyer’s mortgage lender or broker may order the appraisal on their behalf, though the buyer is typically expected to pay for it out of pocket. On average, a home appraisal for a single-family property runs between $300 and $450 while appraisals for multi-family homes can start at around $500.

Once the appraisal is ordered, the appraiser will schedule a time to visit the property. The appraiser will then conduct a thorough review of the interior and exterior of the home to determine what it’s worth. This may require them to take measurements or photos of the property. Appraisals can take a few minutes to a few hours to complete, depending on the details of the home and the appraiser’s methods.

After visiting the home, the appraiser will use the information they’ve collected to create a reasonable estimate for the home’s value. At this stage, the appraiser will also look at the values of comparable homes in the area. Using these comps and what they’ve learned from visiting the home, the appraiser will prepare an appraisal report that includes a figure that represents their perceived value of the home.

A copy of this appraisal report is then shared with the buyer and the buyer’s mortgage lender. It can take anywhere from a week to 10 days for the report to be completed. Sellers can also request a copy of the report.

If a buyer disagrees with the appraisal report, they can request a reconsideration from the lender or opt to pay for a second appraisal.

How To Improve Your Home’s Appraisal Value

The appraisal process is meant to be objective, but appraisers are human. Good curb appeal and clean, uncluttered rooms send a message of a well-maintained home. And they can be achieved without a great deal of time or expense. There are some easy ways to quickly improve the appraised value of your home:

• Lean and uncluttered rooms convey the message that a home is well-maintained.
• Minor cosmetic improvements can make a big difference.
• Point out any major improvements you’ve made to the appraiser, in case they miss them.

On the other hand, you should avoid big expensive improvements just for the sake of increasing your home’s appraisal value. They generally don’t pay off.

Make sure you know your rights as well. If you hire the appraiser to determine your home’s value, the appraisal belongs to you. If you’re refinancing your mortgage and the lender hires the appraiser, the lender is required to provide you with a copy–possibly for a reasonable fee–of the appraisal and any other home value estimates.

If you think the appraiser has the value wrong, first review the written appraisal for errors. Check whether the comps the appraiser chose are reasonably similar to your home. If you still think the price is incorrect, you can appeal the valuation with your lender or ask it to order a second appraisal. 

The Bottom Line

An appraisal is an assessment of the fair market value of a property, business, antique, or even a collectible. Appraisals are used to estimate the value of items that are infrequently traded, and are often rare or unique. The authorized appraiser must have a designation from a regulatory body governing the jurisdiction of the appraiser. Appraisals can be done for many reasons such as tax purposes when valuing charitable donations, but the most familiar form of appraisal is for a property.

Home appraisals can positively or negatively impact the sale of a house or property, and so are an important part of the process of financing a house. A home appraisal is almost always a requirement when purchasing a home with a mortgage, for example, and if you are refinancing your property your lender may hire their own appraiser to make a valuation of your home.