If you are looking for a car loan in the near future, there is a term you should learn today that could save you much grief, hassle and money later on. The term I speak of is known as the rule of 78s. This type of loan is also known as the sum-of-the-digits method. This is an unfair method of yearly interest calculation that still exists with some loan products today. While the rule of 78s is not seen to often these days, it still has one hold over, auto loans. This rule basically is a financing method which pre-determines the interest on your loan. Since the interest on the loan is pre-determined, nearly all of your interest on the loan will paid off before the principal is even touched.
It boils down to weighing your earliest payments with more interest than payments towards the end of the loan. If the loan is not terminated early or totally paid off early, the amount of interest paid on the loan between simple interest, and the Rule of 78s will be equal. With this type of loan, the weights are applied in reverse, applying large weights to early periods. Yet if a consumer decides to pay the loan off early, the interest will be greater, because earlier payments are weighted with more interest. It is rather complex, but needless to say it is not a good deal for the borrower. This is a rather controversial financing tactic that many financial analysts believe to be unfair to the borrower.
This type of loan got it’s start right after the great depression in Indiana, circa 1935. At that time in history lenders were only lending small amounts in general, as they were leery of lending large amounts of capital. To maximize profits they lent small amounts of cash over a 12 month period with the unearned portion of the loans interest pre-determined at the start of the loan. The term rule 78s comes from the sum of the monthly term over 12 months, from 1 to 12; IE 1+2+3+4+5+6+7+8+9+10+11+12= 78.
Most lenders do not use this type of loan format today. Yet it is still be used on car loans. If you are in the market for a car loan, it is rather important that you inquire exactly how interest is being calculated on your loan. While this loan format may not seem so bad when glancing at it, it actually is very bad. For one, you will not be paying down the principle at the start, but rather just the interest on your loan. This makes it impossible to pay the loan off early and save on interest.
The goods news is that in most states it is highly illegal to offer loans with pre-computed interest rates if the loan is longer than 61 months. However there are now many Native American lenders using their reservation address to offer loans online and bypass United States lending laws. Also not that most auto loans are for periods of 36, 42, 48 and 60 months, so you may very well run into this type of loan scheme.
Before taking out any loan you should make an educated decision, knowing all the facts about your loan product. Start this process by knowing where your credit stands via your credit score. Once you know where your credit stands a whole wide world of financial options open up to you. if your score is low, work on raising it, once your score rises, so do your available options. Those whom have a good credit score never need to settle for a loan under the 78s rule.