![]() While the Rule of 78 can be used for certain types of loans (typically for subprime auto loans), there is a much better (and more common) method lenders can use to calculate interest: the simple interest method. How is the Rule of 78 different from simple interest? It’s not good news if you’re trying to get out of debt faster and save money along the way. However, if you try to pay off your loan sooner by making additional payments, under the rule of 78, that additional money will count towards future payments and interest. If you pay off your loan on the original repayment schedule, the Rule of 78 and the simple interest method would cost the same total amount. Month of loan repaymentĪs you can see, the rule of 78 packs the loan with more interest up front. ![]() you still have.Ĭonsider this example, which shows what your interest charge would look like on a 12-month loan with $ 2,000 in interest charges if a lender used the rule of 78 over the life of the loan. ![]() In this case, you would be asked to pay a pre-calculated percentage of your total interest, regardless of the actual principal balance that you have. Imagine you were in the unfortunate situation of having a loan that uses the rule of 78. The end result is that you pay more interest than you should up front.Īdditionally, the Rule of 78 ensures that any additional payment you make is treated as a prepayment of principal and interest due in subsequent months. For example, you would pay 12/78 of the first month’s interest on the loan, 11/78 of the second month’s interest, and so on. The lender allocates a fraction of the interest for each month in reverse order. Loans that last 36 months, 48 ââmonths and so on would follow the same format. Note that a 12 month loan has a rule of 78, but a 24 month loan would follow the rule of 300, since the numbers would add up to this amount. To use the rule of 78 on a 12 month loan, a lender would add the numbers within 12 months using the following calculation: It also makes it more difficult (if not impossible) for borrowers to benefit from the interest savings that might otherwise be achieved by prepaying a loan. The pre-calculated interest charges applied under the Rule of 78 ensure that a lender receives their share of the profits. ![]() In other words, according to the Rule of 78, there are few benefits or savings to be made by paying off a loan in full well before maturity. Under Rule 78, the borrower will pay a much larger portion of the interest earlier in the loan period. âHowever, if a borrower is considering the option of prepaying the loan, it makes a real difference. “If a borrower pays the exact amount owed each month during the term of the loan, the rule of 78 will have no effect on the total interest paid,” said Andy Dull, vice president of credit underwriting for Freedom Financial Asset Management, a debt relief business. The Rule of 78 interest structure favors the lender over the borrower in several ways. Understanding what type of financing will be applied to your loan repayment plan is critical, especially if you intend to repay the loan in advance. Under the Rule of 78, a lender weights interest payments in reverse order, giving more weight to the first few months of the loan repayment period. Borrowers pay more with the rule of 78 than with simple interest. It is widely viewed as unfair to borrowers who may decide to pay off their loans early to get out of debt. The rule of 78 may still be used by some lenders, but not by many. However, the rule can be applied to any loan term. It adds whole numbers between 1 and 12 months, which equals 78. The formula name is based on a 12 month loan term, which was common when the rule was created. The Rule of 78 is a method of calculating and applying interest on a loan that allocates a greater portion of the interest charges to past loan repayments. When the Rule of 78 is implemented, you pay interest so as to ensure that the lender receives their share of the profits even if a loan is prepaid.įortunately, the Rule of 78 was banned nationwide starting in 1992 for loans over 61 months, although it still may not apply in all states regardless of the state. Some lenders use a tricky strategy known as the Rule of 78 to ensure that you pay more off your loan up front through pre-calculated interest charges.
0 Comments
Leave a Reply. |
AuthorWrite something about yourself. No need to be fancy, just an overview. ArchivesCategories |