Auto Shoppers Beware-Rule of 78 vs Simple Interest


The Rule of 78 is a practice by the automobile lending industry which tricks the borrower into receiving a lower rebate when the car loan is paid ahead of schedule or before the end of the term of the loan. This rule is also known as the sum-of-the-year’s digit method, factoring 1 through 12, representing the number of months in a year.

Consumers in installment loans must be aware of the two basic types of auto loans, simple interest loans or the APR method and the pre-computed loans where the Rule of 78 is generally applied.

When you sign on a contract based on the pre-computed loan, you are then obligating yourself to pay back the loan with its principal and the total amount of the interest that will accrue during the entire term of the loan even if you pay the loan ahead of schedule. Why is that? You may ask. The answer is, the interest is computed in advance as lenders normally collects 3/4 of the interest in the first half of the term of the loan.

On the other hand, with simple interest loan or the APR method, you are only being charged on the interest that is accruing each day which is based on the outstanding balance you owe. Clearly, simple interest is a much better and fairer deal for the consumer because there are no prepayment penalties if you repay your loan ahead of schedule.

My take on this, know what you are signing. Ask a lot of questions.before you sign on the dotted line. That contract is binding the moment you accept the terms.

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