Rule of 78

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Rule of 78

A practice in which lenders amortize repayment of short-term loans in a way that the borrower pays most of the interest earlier. For example, in a 12-month loan, the borrower will pay nearly all of the interest over the first, say, six or seven months before his/her payments cover any principal at all. The Rule of 78 guarantees that the lender will still make a profit if the borrower repays the loan early. However, it does not do anything to protect the borrower and is illegal to use for loans with a term longer than 61 months.

Rule of 78.

A practice, called the Rule of 78, means that lenders front-load the interest they charge on a short-term loan to guarantee their profit if you pay off your loan before the end of its term.

In other words, you pay most of the interest before you begin to make substantial repayment of principal.

For example, on a one-year loan, you'd pay 15% of the interest in the first month, 14% in the second month, and only 1% in the last month. The practice is called the Rule of 78 because that's the sum of the twelve payments in a one-year loan (1+2+3+...+12 = 78).

It's illegal to calculate loans with terms longer than 61 months using the Rule of 78, and a number of states outlaw the practice for all loans. But where the Rule of 78 is used, the loans may be described as precomputed or precalculated loans, or as loans that offer a rebate of finance charges if you prepay.

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