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3 min read Published October 17, 2022
Writer: Kellye Guinan. Written by Personal and Business Finance contributor
Kellye Guinan is a freelance editor and writer with over five years ‘ experience within personal finances. She’s also a full-time worker at her local library in which she assists the community access information about financial literacy, as well as other topics.
Editor: Rhys Subitch Edited by Auto loans editor
Rhys has been writing and editing for Bankrate since the end of 2021. They are dedicated to helping readers gain confidence to manage their finances by providing precise, well-studied information that break down complex subjects into bite-sized pieces.
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Precomputed interest is a unique method of calculating the interest on an auto loan which benefits the lender. Instead of dispersing the interest equally over the course of the loan, the interest is front loaded, meaning you pay more interest at the beginning of the loan and less towards the end. If you make minimum payments it is not a difference between pre-calculated interest auto loans. You will get some money back if you pay off the auto loan early however it’s less than with a simple interest auto loan. What is a precomputed auto loan functions «Precomputed» means the lender calculates the interest you will pay over the loan period. Then, it adds that rate of interest on top of the principle, and divides it into monthly payments, similar to regular auto loans that use simple interest. The method of calculating interest benefits lenders if you repay early. They’re not as widespread as simple interest loans. They are more likely to find them offered by buy-here-pay-here dealers and other lenders that work in conjunction with bad credit borrowers. Due to this, they tend to have high interest rates. You’ll receive an interest rate and an annual percentage rate, which includes any additional fees. Precomputed interest is different from. simple interest While precomputed interest front-loads what you pay you, it is possible to split the interest equally. If you pay over the amount of your monthly payment cuts down on the principal amount, which results in a lower interest rate each month. If you only make the minimum payment then there will be no difference between these two ways to determine interest. But if you plan to make an effort to repay your auto loan quickly, simple interest loans are the better choice. It is a rule of law that says 78. Lenders are not legally allowed to charge interest that hasn’t been accrued. But they can change the method of dividing interest throughout the duration of a loan. This rule alters the way you pay, but will not impact the amount you pay. The is among the most popular strategies — and also the foundation for precomputed interest auto loans. The lenders add all the months of the year which total 78, and the interest is then applied in reverse. In an one-year loan you’d pay 12/78 of the total interest due in the initial month. The second month is 11/78, the third month is 10/78 and so on. This means you will pay more at the start of your loan. You can get a rebate on interest if you repay your loan in advance, but you will not save as much than you would with a simple interest loan. Some states have banned using the rule of 78 -in addition, it’s unlawful for loans that last more than 61 months. Examine the laws of your state to make sure your lender doesn’t offer you an illegal loan. How is an interest refund calculated for precomputed auto loans? Refunds are calculated by subtracting the interest you’ve already paid from the balance of interest on your loan. Because the interest is frontloadedthat is, you pay a larger amount at the beginning of the loan the loan is paid off. You will be able to receive less in the time you take to pay off your loan. For example, you will pay about $4,800 in interest on the $30,000 loan with a 60-month repayment term and a 6 percent interest rate. If you pay your loan two years earlier it will be a two-year loan. The lender will add all three of the yearsmultiplying 78 times three to come up with 234 then divide this number by 390 which is the rule of 78 spread over five years. The lender has received 60 percent of the interest by this date. This means you’ll get an amount of refunding the remaining 40%, which is $1,920. Benefits and drawbacks of precomputed interests Precomputed interest is not a problem when you wish you to settle your loan in advance. Otherwise, it will cost the same amount as a regular interest loan. Advantages: Since precomputed interest favors the lender it is much more likely to get provided to those with less than perfect credit. If you aren’t eligible for a standard interest auto loan however, you could still be able to get an interest-only precomputed loan. There is no difference in the amount of interest you pay for a precomputed interest auto loan. If you follow the minimum repayment schedule and you are able to calculate the interest, a precomputed loan is precisely the same as a simple interest loan.
Cons The biggest drawback to precalculated interest is that it can lead to early payments. It is more expensive to pay interest if you pay off your loan in advance and this means you will have lower savings and less responsible. Since lenders are only able to apply the 78 rule for loans that are 30 months or more, you could have higher monthly payments. If you are only eligible for a precomputed interest auto loan then your loan might be more costly between months.
What are the reasons you should stay clear of automated interest-based car loans In general, simple interest is the better option for most borrowers. Even even if you’re not planning to pay back your loan at a later date, your situation could change. In the event that it does, an easy interest loan can mean you’ll pay less in total. Because you pay more in interest when you first take out a precomputed auto loan you’ll be missing the savings if you repay early. It may only be only a tiny variation, but it’s your money. The lower the amount you must pay your lender and the lower your monthly payments, the more favorable. The bottom line is that precomputed interest auto loans are avoidable, but they also are not the worst thing if you only plan to make minimum payments. Still, you should to look for more lenders and, if you are lucky, a better deal.
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Written by Personal and business finance Contributor
Kellye Guinan is a freelance editor and writer with more than five years ‘ experience within personal finance. She also works full-time as a worker at her local library which she assists her local community to gain access to information on financial literacy, among other topics.
Edited by Rhys Subitch Edited by Auto loans editor
Rhys has been editing and writing for Bankrate since late 2021. They are passionate about helping readers feel confident to take control of their finances through providing clear, well-researched information that breaks down complicated topics into bite-sized pieces.
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