Rule of 78

Demystifying the Rule of 78: Understanding Loan Interest Calculation

Deciphering the Rule of 78

What is the Rule of 78?

The Rule of 78, utilized by some lenders to calculate loan interest charges, assigns more weight to the early months of a loan cycle. This skewed calculation benefits the lender, potentially increasing profits while reducing potential savings for the borrower.

How Does it Work?

The Rule of 78 allocates pre-calculated interest charges that favor the lender, particularly for short-term loans or if the loan is paid off ahead of schedule. This methodology results in a greater portion of interest being paid earlier in the loan term.

Unraveling Rule of 78 Loan Interest

Understanding Calculation Methodology

Unlike simple annual percentage rate (APR) loans, the Rule of 78 employs a more intricate interest calculation schedule. It is commonly used by short-term installment lenders catering to subprime borrowers. The total interest for each month is weighted in reverse order, with earlier months bearing more significant interest burdens.

Rule of 78 vs. Simple Interest

While the total interest paid over the entire loan term remains the same between the Rule of 78 and simple interest methods if the loan is not terminated early, the Rule of 78 results in higher interest payments for early loan payoffs. Legislation in 1992 restricted the use of the Rule of 78 for loans exceeding 61 months in the United States.

Exploring Practical Implications

Impact on Borrowers

The Rule of 78 may lead to slightly higher interest payments for borrowers who opt for early loan repayment. However, the difference in savings between Rule of 78 and simple interest loans is minimal for shorter-term loans.

Legal Considerations

Certain states have implemented stricter regulations on Rule of 78 loans, while some have prohibited their use altogether. Prospective borrowers are advised to consult with their state's Attorney General's office before entering into any loan agreements involving the Rule of 78.