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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.