rule of 78

  

Definition

Method of computing interest-refund on a fixed installment loan (with add on interest) that is paid-off before its full duration (maturity). A refund is necessitated because, on such loans, interest is not paid uniformly but forms a larger percentage of the installment in the early months than in the later months. Therefore, a pre-paying borrower would have already paid more interest than required. To determines how much interest was paid in each month: (1) add up the number of the digits of the months of the loan period; for example, if this period is one year, the total number is 78 (1+2+3+ ... 11+12); (2) divide this total into the numbered payments in reverse order and multiply with the monthly installment amount; for example, if the installment amount is $200, the interest paid in the first month is $30.76 (12 ÷ 78 x 200), for the second month it is $28.20 (11 ÷ 78 x 200), for the third month $25.64 (10 ÷ 78 x 200), and so on. The name of this method, however, is misleading because, for loans paid over more than one year, the total of the digits of months will exceed 78. Called also sum of the digits method.

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