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3 min read Published on 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 of experience in personal finances. She also works full-time as a worker at her local library in which she assists the community access information about financial literacy, in addition to other subjects.
The edit was done by 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 concise, well-researched and well-studied content that breaks down otherwise complex subjects into bite-sized pieces.
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Precomputed interest is an uncommon method of calculating the the interest rate on an automobile loan that benefits the lender. Instead of spreading the interest evenly out over the course of the loan the interest is front-loaded -- meaning you pay more rate at the start of your loan and less towards the end. If you only make the minimum payments it is not a difference between and precomputed auto loans. You will get some money back if pay off the auto loan in advance however, it's less than with a simple auto loan. What is a precomputed auto loan operates "Precomputed" is the term used to describe how the lender calculates the interest that you'll be paying over the loan duration. It then adds this amount to your principal, and divides it into monthly payments, similar to standard auto loans which use simple interest. The method used to calculate interest favors lenders when you pay early. They're not as popular as simple interest loans. You are more likely to get them from buy-here-pay-here dealers as well as other lenders who deal on behalf of bad credit borrowers. This is why they typically have high interest rates. You will receive the interest rate along with an annual percent rate which includes any additional charges. Precomputed interest in comparison to. simple interest. Precomputed interest charges you upfront, split the interest paid evenly. Paying higher than your minimum decreases the principal amount, which in turn results in a lower interest rate the next month. If you just make the minimum amount then there will be no distinction between these two methods to calculate interest. However, if you are planning to pay off your auto loan quickly, interest-only loans are the best option. It is a rule of law that says 78. Lenders aren't legally permitted to charge you interest which isn't earned. However, they are able to alter the way interest is divided over the course of a loan. The rule of 78 alters how you but not the total amount you have to pay. It is among the principal tactics -- and the basis for precomputed interest auto loans. Lenders add up all the months in the year, which total 78, and the interest is then applied in reverse. In the course of a one-year loan you'd pay 12/78 of the total amount due in the initial month. The second month would be 11/78, the third month is 10/78 and so on. This means you will be paying more at the beginning the term of your loan. You may be eligible for a discount on interest if you take care to pay off your loan early, though you will not save as much than you would with an interest loan. Some states have banned this rule of 78in addition, it's prohibited for loans lasting more than 61 months. Examine the laws of your state to ensure your lender isn't offering you an illegal loan. How is an interest refund calculated for precomputed interest auto loans? The refunds can be calculated as a result of subtracting the interest you've previously paid off from interest remaining on your loan. However, since the interest is frontloaded -that 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 have to complete the repayment of the loan. For instance, you'll be paying around $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 in advance then the lender will add all three of the years -multiplying 78 times three to arrive at 234 then divide this number by 390 which is the standard of 78 spread over five years. The lender will have earned 60 percent of its interest at this point. This means you'll get an amount of refunding the remaining 40 percent -- totaling $1,920. Benefits and disadvantages of precomputed interest Precomputed interest is not a problem if you want you to settle your loan in advance. In any other case, it will cost the same amount as a regular interest loan. Advantages: Since precomputed interest favors the lender and the lender, they are most likely to be granted to those with less than perfect credit. If you don't qualify for a basic interest auto loan but you might be eligible for precomputed interest loan. There's no distinction in the amount of interest that you pay on an auto loan. If you follow the minimum payment schedule and you are able to calculate the interest, a precomputed loan is precisely identical to a regular interest loan.
Cons The biggest drawback to precalculated interest is the possibility of early repayments. It is more expensive to pay interest if you have to pay back your loan early that means less savings for being financially responsible. Because lenders are limited to using the 78 rule for loans that have terms of 60 months or less, you might pay more in monthly installments. If you're only qualified for a precomputed auto loan and you are not eligible for precomputed interest auto loans, your loan might be more costly in the month.
What are the reasons you should stay clear of the use of precalculating interest on automobile loans In general simple interest is the best choice for nearly every borrower. Even even if you're not planning to pay back your loan at a later date it is possible that your situation will alter. In the event that it does, a straightforward interest loan could mean that you pay lower overall. Because you pay more in interest at the start of an auto loan and you'll lose the savings if you make a payment in a timely manner. It could be an insignificant variation, but it's your money. The less you have to pay your lender, the more favorable. The bottom line is that precomputed auto loans can be avoided however, they're not the most ideal option if you only plan to make minimum payments. Still, you should to locate more lenders and possibly a better rate.
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Written by Business and personal finance contributor
Kellye Guinan is a freelance editor and writer with more than five years of experience in personal finance. She also works full-time as a worker at her local library which she assists her local community to get information about financial literacy, among other topics.
The edit was done by Rhys Subitch Edited by Auto loans editor
Rhys has been editing and writing for Bankrate since the end of 2021. They are passionate about helping readers gain the confidence to take control of their finances through providing precise, well-researched and well-understood information that breaks down complicated subjects into digestible pieces.
Auto loans editor
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