Unveiling the Mystery of Precomputed Interest Car Loans
Sunday, Jan 26, 2025 12:15 am ET
2min read 
Precomputed interest car loans are a unique type of auto loan that benefits lenders by front-loading the interest payments. This means that the majority of the interest is paid at the beginning of the loan term, and the lender collects a larger portion of the interest early on, even if the borrower pays off the loan ahead of schedule. This method is often used by buy-here-pay-here dealers and other lenders that work with borrowers with bad credit, and they tend to have high interest rates.
The rule of 78 is a method used by lenders to calculate interest in reverse order, which means that the interest paid in the early stages of the loan is higher, and it decreases over time. This method is commonly used in precomputed interest car loans, where the total interest is calculated upfront and divided evenly across the loan term. As a result, the majority of the interest is paid at the beginning of the loan, and the lender benefits more if the borrower pays off the loan early.
There are legal considerations surrounding the use of the rule of 78. Lenders are not allowed to charge interest that hasn't accrued, but they can change how interest is divided throughout a loan. Some states have banned the use of the rule of 78, and it is nationally illegal for loans lasting 61 months or longer. It is essential to check your state's laws to ensure that your lender is not offering you an illegal loan.
In the example provided in the materials, a $26,000 auto loan at a 12% interest rate and a 48-month term has a precomputed interest term equal to 1,176. If the borrower chooses to pay off the loan at the 20-month mark, they would receive a refund of $2,402.75. This refund is calculated by subtracting the interest already paid from the remaining interest on the loan. The lender will have earned 65 percent of its interest even before the halfway point, so the borrower will receive a refund for the remaining 35 percent.
The precomputed interest rebate formula is used to calculate the refund amount. The formula is (R * (R +1)) / (T * (T+1)) = D * I = Rebate Amount, where R is the remaining loan term, T is the total loan term, D is the decimal representing the percent of the loan paid, and I is the total interest of the loan. In this example, the borrower would multiply 0.35 by $6,865 to get the final rebate amount of $2,402.75.
In conclusion, precomputed interest car loans are a unique type of auto loan that benefits lenders by front-loading the interest payments. The rule of 78 is a method used by lenders to calculate interest in reverse order, which is commonly used in precomputed interest car loans. There are legal considerations surrounding the use of the rule of 78, and it is essential to check your state's laws to ensure that your lender is not offering you an illegal loan. The precomputed interest rebate formula is used to calculate the refund amount if the borrower pays off the loan early.
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