werner@ut-ngp.UUCP (03/19/84)
STOMP
> what is the rule of 78 often found in loan agreements?
it applies to the case when you want to prepay the loan, and
regulates how to calculate the amount you have to pay to cancel the
loan.
When you make a monthly payment, part is for interest, of course,
sometimes there is a managing or handling fee, the rest should
be applied to reduce your debt.
You might have expected that a prepayment could be simply calculated
by subtracting from the principal original debt the amount of money
in your payments which did not go for interest, etc.
Well, think again, as the rule of 78 is a table of percentages
or fractions, which specifies how much the prepayment amount is
after X monthly (or whatever) payments. This table works to your
disadvantage, as the amount comes out as more as you might otherwise
have expected.
I hope, you posed this question to your loan-officer before signing
anything, and that he gave you a similar explanation. If he did not
you have reasons to complain to whatever state-board for banking may
exist in your state, and you might be able to renegotiate the loan,
or cancel it completely. However, don't get your hopes up, it
probably is not worth the effort.
Cheers,
Werner
The RULE of 78: just another way to keep banks profitable.halle1@houxz.UUCP (J.HALLE) (03/19/84)
What does it mean? It means you got a bum deal. You dare not pay it off early or you get hit with a whopper penalty. Conceivably you could end up owing more than the original principal. The name has to do with the method of calculating interest. If you have n payments, you divide the principal into n parts. You then have n + (n-1) + ... + 2 + 1 interest units, or n(n+1)/2. If n=12, total = 78, hence the name. Sum of digits is a synonym. This formula is used to calculate how much interest and principal is left at any time. Basically, you calculate the total interest owed and add it to the principal. This is the new principal you owe. Check with the bank for exact details.
topher@cyb-eng.UUCP (Topher Eliot) (03/20/84)
Someone said: > What does it mean? It means you got a bum deal. You dare not pay it off > early or you get hit with a whopper penalty. Conceivably you could end > up owing more than the original principal. This is over-stated. First of all, use of the "rule of 78s" is fairly common in many businesses, so it's not like you were robbed blind. And as long as you don't fall behind in your payments, there is utterly no way you can end up owing more than the original principal. Here's how it works (or at least how it works in one real-life loan I have): The total amount that you would have to pay the lendor over the life of the loan is calculated on the standard basis of frequently-compounded interest (although sometimes they don't compound it, which just helps the borrower). The principal amount is subtracted back out of this, yielding the total amount of interest to be payed over the course of the loan. The rule of 78's comes in to calculate how much of this total interest is owed if the borrower chooses to pay off early. Suppose you have a 12-month loan with monthly payments. Take the number of months you've had the money at each payment, and sum them up (1 + 2 + 3 ... + 12) voila! = 78. The agreement is that if you pay off 1 month early, you get to keep 1/78th of the total interest as calculated above; if you pay off 2 months early, you get to keep (1+2)/78ths, 3 months early lets you keep (1+2+3)/78ths, and so forth. The net result is that if you just make your monthly payments, it's exactly the same as if they had used vanilla-flavored interest calculations. If you pay off very early in the loan or very late, it's pretty close to that. If you pay off in the middle of the loan, you end up paying a significantly higher amount than if your payoff amount had been calculated by constant compounding. Hmmm, now that I think about it, I guess you COULD end up paying more than the original principal amount, at least if you payed the loan off at the end of the first payment period. But that's not really unreasonable.
jdb@qubix.UUCP (Jeff Bulf) (03/21/84)
Im sure others will post technical descriptions. You will be amazed at the
brazenness of the scam.
It means roughly that no matter how quickly you re-pay the loan, the lender
still gets to keep most of the interest that they would have gotten if you
had taken the full time to pay.
As out-front an example of the Golden Rule as you are likely to find.
(that is, "Thems as has the gold makes the rules")
best of luck ...
--
Dr Memory
...{decvax,ucbvax,ihnp4}!decwrl!qubix!jdbntt@dciem.UUCP (Mark Brader) (03/21/84)
Now that the Rule of 78 has been explained, I would like to add one point. The difference between the rule and the really correct interest calculation is not that large, *if* the loan is in fact being paid off in 12 payments (which is where the 78 comes from, remember: 1+2+...+12). But if it is a longer-term loan that is paid off in, say, 36 or 60 payments, the difference between "Rule of 78" -- which is called that anyway -- and the correct calculation becomes much larger when you pay it off after about half the term. Mark Brader
phil@unisoft.UUCP (Phil Ronzone) (03/21/84)
Rule of 78: when you borrow money, say for a year, and thus have a year, or 12 months to repay it in, it is assumed that you have use of 12 parts of the money for the first month, 11 parts of the money the next month, 10 parts of the money the next month, ..... 12 + 11 + 10 + ... = 78. It is most often dealt with when prepaying a loan, since most loans have equal monthly payments, with the principal and interest payments varying.
wally@cornell.UUCP (Wally Dietrich) (03/22/84)
One other important thing about the rule of 78's is that since you pay most of the interest at the beginning of the loan period, you can take a bigger tax deduction for it at the beginning of the loan period.
rjh@ihuxj.UUCP (Randolph J. Herber) (03/23/84)
A numerical example maybe will clear up the confusion about the
"rule of 78's."
AMOUNT OF LOAN: $1,000.00
APR: 23.99998
MONTHS TO PAY: 12
PAYMENT AMOUNT: $94.56 = P
LAST PAYMENT AMOUNT $94.54
FIRST PAYMENT: 1/1984
RULES OF 78'S AMOUNT $1.726923 = R = $134.70 / 78
AFTER AFTER
PAYING PAYING PAYMENT AMOUNT
DATE INTEREST REPAY OWED PAY OUT AMOUNT BY 78'S
12/1983 $0.00 $1000.00 $1134.70-78*R=$1000.00
1/1984 $20.00 $74.56 $925.44 $1040.14-66*R= $926.16
2/1984 $18.51 $76.05 $849.39 $945.58-55*R= $850.60
3/1984 $16.99 $77.57 $771.82 $851.02-45*R= $773.31
4/1984 $15.44 $79.12 $692.70 $756.46-36*R= $694.29
5/1984 $13.85 $80.71 $611.99 $661.90-28*R= $613.55
6/1984 $12.24 $82.32 $529.67 $567.34-21*R= $531.07
7/1984 $10.59 $83.97 $445.70 $472.78-15*R= $446.88
8/1984 $8.91 $85.65 $360.05 $378.22-10*R= $360.95
9/1984 $7.20 $87.36 $272.69 $283.66- 6*R= $273.30
10/1984 $5.45 $89.11 $183.58 $189.10- 3*R= $183.92
11/1984 $3.67 $90.89 $92.69 $94.51- 1*R= $92.78
12/1984 $1.85 $92.69 $0.00 $0.00- 0*R= $0.00
TOTAL 1984 $134.70 $1,000.00thomson@uthub.UUCP (Brian Thomson) (03/23/84)
Is there a difference between the "Rule of 78" and the "Rule of 78s"?
The Rule of 78 that I remember says that a principal increasing at the
rate of N % annually, compounded, will double in approximately
78 / N years.
--
Brian Thomson, CSRG Univ. of Toronto
{linus,ihnp4,uw-beaver,floyd,utzoo}!utcsrgv!uthub!thomsongam@proper.UUCP (Gordon Moffett) (03/24/84)
I have recently entered into a loan agreement which includes the following: "In the event of prepayment in full, you are entitled to a partial refund of the unearned FINANCE CHARGE computed on the rule of 78's." What does this mean to me, Al Franken?