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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References in periodicals archive ?
Before the new rules came into effect, if you asked to repay early, many lenders used a calculation called the Rule of 78 to work out how much interest they would lose.
Most lenders - including these three - also use a complex interest calculation called the Rule of 78 to increase the total payable if you settle early.
The new legislation abolishes the Rule of 78, used by lenders to calculate how much consumers have to pay when they settle a loan early, and replaces it with a new, fairer, actuarial method to calculate costs.
4 Always look at the terms and conditions of any loan agreement entered into and check for early redemption penalties and those who calculate their loans using Rule of 78 (where interest is calculated on a monthly rather than daily basis) as this will increase the actual cost of the loan;
NCheck any loan agreements for old-fashioned interest calculations such as the rule of 78 (where interest is calculated monthly rather than daily on personal loans) which the DTI plans to abolish, as well as restricting early redemption penalties to one month's interest.
About 70pc of all personal loans are settled early, but under current rules people have to pay a penalty to do so, calculated using the so-called Rule of 78 formula, which tends to favour the lender.
It's due to a clause in the Consumer Credit Act called the Rule of 78 which says you may still be liable for the interest you would have expected to pay over the full term of the loan.
But the notorious Rule of 78, which hits millions of borrowers, won't go until next summer.
If you think you might want to swap lenders again in future, avoid ones that charge early redemption penalties or use a tricky calculation called the Rule of 78 to increase the amount you pay if you settle early.
It does use the Rule of 78 calculator -like many other lenders -on early repayments, he says, but will not levy redemption charges.
You should also bear in mind that under an obscure clause called the Rule of 78, even if you are able to pay the debt off early, you may still have to pay the interest you would have had to pay if the loan ran for its full term.