by Craig J Davenport

Created on: September 03, 2008   Last Updated: March 27, 2010

This is something that needs to be discussed. In the fifties and sixties most loans were either discount interest or add on interest. If you had borrowed money at that time, for instance one thousand dollars for one year at ten percent discount interest, you would only get nine hundred dollars in proceeds. You still need one thousand dollars so you have to borrow another one hundred dollars. The ten percent of the hundred is deducted from the hundred, leaving ninety in proceeds. So you need another ten dollars to get the thousand. I know you get the picture now on discount interest, which was mainly used by loan companies.

The banks used add on interest, which was the simplest way to do business. If you borrowed one thousand dollars and the lender used add on, if the rate was ten percent, in round numbers the interest is one hundred dollars. It actually was determined by how long the first payment was stretched out. Forty five days would be a little more interest than thirty days til the first pmt.

In 1969 the Fed. govt. became involved and said since the Payor was declining the balance on the loan every month the lenders were not disclosing the proper interest rate. They passed the Truth In Lending Bill, which says you can call the interest rate on the loan based on the average use of funds. This meant that the ten percent rate on the one thousand you borrowed was wrong only in the fact they called it ten percent. If you had borrowed one thousand after 1969 you would only be using the lender's money at a rate of approximately five hundred dollars. You had paid the one thousand down to about half of the original balance, so you were paying almost twenty percent on that particular loan. So came the term Annual Percentage Rate or APR. Remember now it is based on the average use of funds borrowed. The simpler of the three means of lending and borrowing is add on. If you ask any intelligent person on the street about the interest he would pay on one thousand dollars at ten percent for one year, nine of ten of them would say one hundred dollars. The correct answer would be fifty dollars.

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