Rule of 78s - Precomputed Loan

Precomputed Loan

The Rule of 78s deals with precomputed loans, loans whose finance charge is calculated before the loan is made. Finance charge, carrying charges, interest costs, or whatever the cost of the loan may be called, can be calculated with simple interest equations, add-on interest, an agreed upon fee, or any disclosed method. Once the finance charge has been identified, the Rule of 78s is used to calculate the amount of the finance charge to be rebated (forgiven) in the event that the loan is repaid early, prior to the agreed upon number of monthly payments. It should be understood that with precomputed loans, a borrower not only owes the lender the principal amount borrowed, but the borrower owes the finance charge as well. If $10,000 is lent and the precomputed finance charge is $3,000, the borrower owes the lender $13,000 at the time the loan is made, whereas a simple interest borrower owes the lender only the $10,000 principal and monthly interest on the unpaid principal.

A simple explanation would be as follows: Suppose the total finance charge for a 12 month loan was $78.00. That figure is representative of the sum of digits by adding the numbers together..i.e. 12,11,10,9,8,7,6,5,4,3,2,1 = 78. If a person prepaid a consumer loan in 3 months, the financial institution would refund the sum of the "remaining" digits....(i.e. 9,8,7,6,5,4,3,2,1 or $45.00. They in essence would retain the first three (3) numbers...12,11,10 or $33.00. Thus the consumer would not receive as much of a refund if it were divided equally by 12 months ($6.50 per month). Under this scenario they would have received a refund of $58.50, much more beneficial than the $45.00 refund.