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3 min read Published on October 17, 2022.
Written by Kellye Guinan. Written by personal and Business Finance Contributor
Kellye Guinan is a freelance editor and writer who has more than five years ' experience within personal financial matters. She's also a full-time employee at the library in her town in which she assists the community gain access to information on financial literacy, as well as other subjects.
The edit was done 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 gain confidence to take control of their finances with concise, well-researched and well-studied content that break down complex topics into digestible chunks.
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Precomputed Interest is a rare method of calculating rates on an auto loan which benefits the lender. Rather than dispersing the interest equally throughout the duration of the loan it is front-loaded -- meaning that you pay more in interest at the beginning of the loan and less at the end. If you pay the minimum amount and do not make any distinctions between the precomputed auto loans. You will get some money back if pay off the auto loan in advance however it's lower than a standard auto loan. How a precomputed interest auto loan operates "Precomputed" is the term used to describe how the lender calculates the interest that you'll be paying over the loan period. It then adds this interest to the principal and splits it into monthly payments, similar to traditional auto loans which use simple interest. The way interest is calculated favors lenders when you pay early. They're not as widespread as traditional interest loans. They are more likely to find them offered by buy-here-pay-here dealers and other lenders that deal in conjunction with bad credit borrowers. Due to this, they typically have very high interest rates. You will receive the interest rate along with an annual percentage rate that also includes any additional fees. Precomputed interest vs. simple interest. Precomputed interest charges you upfront, split the interest paid evenly. Paying more than the minimum reduces the principal amount, which, in turn, results in a lower interest rate each month. If you just make the minimum amount then there will be no distinction between the two methods to calculate interest. However, if you are planning to pay off your auto loan quickly, interest-only loans are the best choice. This is the rule that applies to 78. Lenders aren't legally permitted to charge you interest that isn't earned. However, they are able to alter the way interest is divided across the duration of a loan. The rule of 78 can alter how you pay but will not impact the amount you pay. This is among the principal methods -- and is the basis for precomputed auto loans. Loan lenders add up all months of the year, which total 78, and the interest is then applied in reverse. For an one-year loan you'd have to pay 12/78 percent of total amount due in the initial month. The second month would be 11/78, the 3rd month is 10/78 and the cycle continues. This means you will be paying more at the beginning of your loan. You can get a rebate on interest if you pay off your loan in advance, but you won't save as much as you could with a standard interest loan. Certain states have prohibited this rule of 78in addition, it's illegal for loans that last 61 months or longer. Be sure to check your state's laws to ensure that your lender isn't offering you the wrong loan. How is an interest refund calculated for precomputed interest auto loans? They are calculated using subtracting the amount of interest you've already paid from the balance of interest on your loan. However, since the interest is frontloaded -- you pay a greater portion at the beginning of the loan -- you will have less refunded the longer you have to repay the loan. For instance, you'll pay about $4,800 in interest on the $30,000 loan with a 60-month repayment term with a 6 percent interest rate. If you pay off your loan two years earlier it will be a two-year loan. The lender will add 3 years of interest -- multiplying 78 by three to get 234 -- then divide the result by 390, which is the standard of 78 spread across five years. The lender will have earned 60 percent of its interest at this moment. Therefore, you'll receive an amount of refunding the remaining 40 percent , totalling $1,920. Benefits and disadvantages of precomputed rates of interest Precomputed rate of interest is only an advantage when you wish be able to repay your loan early. In any other case, it will cost you exactly the same amount as a regular interest loan. Advantages: Since precomputed interest favors the lender it is most likely to be provided to those with less than perfect credit. If you're not eligible for a simple interest auto loan, you may still be able to get a precomputed interest loan. There is no difference in how much interest you pay for the precomputed interest auto loan. If you follow the minimum payment plan, a precomputed interest loan is precisely the same as a simple interest loan.
Cons The major drawback with precalculated interest is the possibility of early repayments. It is more expensive to pay interest if you repay your loan in advance, which means less savings to be financially responsible. Since lenders can only use the 78-day rule on loans with terms of 30 months or more, you might have higher monthly payments. If you are only eligible for a precomputed-interest auto loan then your loan could be more expensive in the month.
Why you should avoid the use of precalculating interest on auto loans In general basic interest will be the best option for most borrowers. Even even if you're not planning to repay your loan at a later date, your situation could change. If it does, a straightforward interest loan can mean you'll pay lower overall. Because you pay more in interest in the beginning of a precomputed auto loan, you'll miss the savings if you pay off your loan early. It may only be an insignificant difference, but it's your money. The less you need to pay your lender and the lower your monthly payments, the more favorable. The bottom line is that precomputed interest auto loans are not a good idea however they are not a bad thing for those who only intend to make minimum payments. But, it is important to find more lenders -- and, if you are lucky, a better deal.
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Written by Business and personal finance contributor
Kellye Guinan is a freelance editor and writer with more than five years ' experience within personal financial matters. She also works full-time as a librarian at the local library in which she assists the community access information about financial literacy, as well as other topics.
Edited by Rhys Subitch Edited by Auto loans editor
Rhys has been editing and writing for Bankrate since the end of 2021. They are dedicated to helping their readers gain the confidence to take control of their finances with concise, well-studied information that is broken down into complex topics into manageable bites.
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