Relay-Version: version B 2.10 5/3/83; site utzoo.UUCP Posting-Version: version B 2.10.1 6/24/83; site cyb-eng.UUCP Path: utzoo!watmath!clyde!floyd!harpo!seismo!ut-sally!cyb-eng!topher From: topher@cyb-eng.UUCP (Topher Eliot) Newsgroups: net.consumers,net.misc Subject: Re: What is "rule of 78's"? Message-ID: <350@cyb-eng.UUCP> Date: Tue, 20-Mar-84 11:15:48 EST Article-I.D.: cyb-eng.350 Posted: Tue Mar 20 11:15:48 1984 Date-Received: Wed, 21-Mar-84 02:48:00 EST References: <1070@proper.UUCP> <709@houxz.UUCP> Organization: Cyb Systems, Austin, Texas Lines: 34 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.