Car Loan - Rule 78

• flash9933

  21 Apr 04, 18:24

  What does this rule all about? It is somehow a ocndition pertaining to car loan for up to $55K and $55K and above.
• TAL

  23 Apr 04, 02:09

  I think if you search around, some sites will provide illustration that explain rule of 78 quite well.
  
  Basically if our interest is $500 per year for a 7 year loan, if we decide to pay off everything by the 3rd year, we should expect to save interest incurred from the 4th year onwards. That wil work out to be $500 x 4 = $2000 in savings. But rule of 78 doesn't work like that.
  
  It assumes that the payment in the earlier part of the loan period to go towards payment of interest instead of the principal sum. It's only towards the end that a large part of our monthly payment goes towards payment of the principal sum. So terminating the loan early will be result in substantial interest savings.
  
  Hope I succeeded in confusing you further.
  
  Seriously, check out the website. They do a better job.
  
  
• stealthguy

  23 Apr 04, 10:16

  Originally posted by flash9933:

  What does this rule all about? It is somehow a condition pertaining to car loan for up to $55K and $55K and above.

  Let me try to illustrate.
  
  Suppose you take a 10 year loan of $50,000 at 2% interest.
  So the interest you owed the bank is $50,000x10yearsx2% =$10,000
  Add this to the sum you borrowed = $10,000+50,000= $60,000
  
  So the amount you pay each month = $60,000/10 years/12 months = $500
  
  Let's now assume that you want to pay off the loan after 2 years
  So you still owed the bank 8 years of repayment = $60,000 x 8 / 10 = $48,000
  This is inclusive of a remaining interest of = $50,000 x 8 years x 2% = $8,000.
  
  This is unfair to you because you are paying interest after you terminated the loan. To make you "happy", the bank uses Rule 78 to give you some "rebate".
  
  The rebate formula is (Remaining Interest) x n(n+1) / N(N+1)
  where
  n = remaining loan period (in months)
  N = original loan period (in months)
  
  So in the example, the remaining interest is $8,000, n=96 (8 yrs), N=120 (10 yrs)
  Therefore, the rebate is $8,000 x 96(96+1) / 120(120+1) = $5,131
  
  Rightfully, the rebate should be $8,000. But it's better than nothing.