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What does "Rule of 78s" mean?
Dear Dollar Diva,
I have a 60-month car loan and want to pay if
off 15 months early. When the person at the finance company told
me the payoff amount, I challenged it. He told me that my loan is
a "Rule of 78s" loan, not a simple interest loan, and because of
that the largest portion of interest has already been paid. He is
also talking about my "savings" even though the payoff amount is
more than it should be. What does "Rule of 78s" mean?
Andrew
The "Rule of 78s" means that if
you pay your loan off early, you are going to get smacked with a
prepayment penalty. It's pretty sneaky, and a lot of people sign
the loan agreement without understanding what it's all about.
With the "Rule of 78s," the interest is computed
for the term of the loan using a standard amortization table, and
you agree to pay the principal and interest over the term of the
loan. However, if you decide to prepay, the lender recalculates
the loan using the "Rule of 78s."
When he does his new calculations, he applies
more of your prior payments toward interest, and less of your prior
payments toward principal. Since less is applied toward principal,
your loan balance is higher than it would have been using a regular
amortization schedule.
To add insult to injury, he will then have the
nerve to tell you that you're saving money or getting a rebate by
paying early. After all, he's not going to collect the total interest
you agreed to pay when you signed the contract. Never mind that
the interest you agreed to pay was for 60 months, not 45 months.
It's sneaky, but it's legal if it's in the contract you signed.
But check the contract to be sure it's in there before you pay up.
And if it is, remember, first time it happens, shame on him.
For more on the "Rule of 78s" read the Diva's
"When
is a rebate really a rip-off?"
 DOROTHY
ROSEN has a master's degree in finance, with a specialization in
accounting, from the Kellogg Graduate School at Northwestern University
in Evanston, Ill. Rosen has more than 15 years of experience in
the financial arena, serving in Illinois and Florida as a certified
public accountant, financial consultant, expert witness and educator.
She is owner of Dorothy Rosen, CPA, a public accounting firm that
serves individuals and small businesses.
-- Posted: March 5, 2001 |
