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3 min read . Published on October 17, 2022.

Authored by Kellye Guinan. Written by Personal and business finance contributor

Kellye Guinan is a freelance editor and writer who has more than 5 years experience working in the field of personal finances. She also works full-time as a worker at her local library in which she assists the community get information on financial literacy, among other subjects.

Edited by Rhys Subitch Edited by Auto loans editor

Rhys has been editing and writing for Bankrate since the end of 2021. They are committed to helping readers gain the confidence to manage their finances by providing clear, well-researched information that breaks down otherwise complex topics into manageable bites.

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Precomputed interest is an uncommon method of calculating interest on an auto loan that benefits the lender. Rather than spreading the interest evenly out over the course of the loan it is front loaded, meaning you pay more interest at the beginning of the loan and less at the end. If you pay the minimum amount it is not a difference between pre-calculated auto loans. You can get some cash back if pay off your auto loan in advance, but it will be less than with a simple auto loan. What is a precomputed auto loan works «Precomputed» is the term used to describe how the lender determines the amount of interest you’ll pay over the loan duration. Then, it adds that rate of interest on top of the principle and splits it into monthly payments as with regular auto loans which use simple interest. The way interest is calculated benefits lenders if you repay early. They aren’t as common as regular interest loans. You are more likely to see them offered by buy-here, pay-here dealers and other lenders that are working in conjunction with bad credit borrowers. Due to this, they typically have very high interest rates. The rate you pay will be an interest rate and an annual percent rate, which includes any additional fees. Precomputed interest vs. simple interest. Precomputed interest charges you upfront divide the interest equally. If you pay higher than your minimum payment decreases the principal, which, in turn, results in a lower interest rate the next month. If you just make the minimum amount of payment then there will be no distinction between these two methods to calculate interest. If you intend to pay off your auto loan quickly, interest-only loans are the best option. The rule of 78 Lenders aren’t legally permitted to charge interest that isn’t earned. But they can change the way interest is divided across a loan. A rule called 78 alters how you pay but will not impact the total amount you pay. This is one of the main methods — and is the basis for precomputed interest auto loans. Loan lenders add up all months of the year which is 78, and the interest is then applied in reverse. For the course of a one-year loan, you would have to pay 12/78 percent of interest due in the initial month. The second month would be 11/78, the third month is 10/78 and so on. This means that you’ll have to pay more at the start and end of the loan. You may be eligible for a discount on interest when you pay off your loan early, though you will not save as much than you could with a standard interest loan. Some states have banned the rule of 78 — and it is nationally unlawful for loans lasting 61 months or longer. Check your state’s laws to make sure your lender doesn’t offer you the wrong loan. What is the method by which interest refunds are calculated for precomputed auto loans? They are calculated using subtracting interest you’ve already paid from the interest remaining on your loan. However, since the interest is frontloadedthat is, you pay a larger amount at the beginning of the loan the loan is paid off. You will receive less money back the longer you have to pay off the loan. For instance, you’ll be paying around $4,800 in interest on an $30,000 loan with a 60-month repayment term with a 6 percent interest rate. If you pay off your loan two years early then the lender will add the first three yearsmultiplying 78 times three to arrive at 234 then divide this number by 390 which is the rule of 78 spread over five years. The lender has made 60 percent of its interest by this date. So you will receive a refund for the remaining 40 percent , totalling $1,920. Benefits and disadvantages of precomputed interests Precomputed interest is not a problem if you want to pay off your loan early. In any other case, it will cost the same as a simple interest loan. Pros Because precomputed interest benefits the lender it is much more likely to get offered to those with less than perfect credit. If you don’t qualify for a standard interest auto loan however, you could still be eligible for an interest-only precomputed loan. There’s no difference in how much interest you pay for a precomputed interest auto loan. If you adhere to the minimum payment plan, a precomputed interest loan is precisely like a standard interest loan.

Cons The biggest drawback to precalculated interest is the possibility of early repayments. You’ll pay more interest if you repay your loan early that means lower savings and less responsible. Because lenders are limited to using the rule of 78 on loans that have terms of sixty months and less, it is possible that you might have higher monthly payments. If you only qualify for a precomputed-interest auto loan, your loan may be more expensive between months.

What are the reasons you should stay clear of precomputed interest auto loans In general basic interest will be the ideal choice for nearly every borrower. Even if you don’t have plans to pay off your loan at a later date, your situation could change. And if it does, a simple interest loan will mean you pay lower overall. Because you pay more interest in the beginning of a precomputed auto loan, you’ll miss out on savings if you make a payment in a timely manner. It may only be an insignificant difference, but it’s still your money. The lower the amount you must pay your lender the less you pay, the better. The bottom line is that precomputed auto loans are avoidable however they are not a bad thing if you only plan to pay minimum monthly payments. But, it is important to look for more lenders and, if you are lucky, a better deal.

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Written by Personal and business finance contributor

Kellye Guinan is a freelance editor and writer with over 5 years experience working in the field of personal financial matters. She is also a full-time librarian at the local library in which she assists the community gain access to information on financial literacy, in addition to other topics.

Editor: Rhys Subitch Edited by Auto loans editor

Rhys has been writing and editing for Bankrate since late 2021. They are dedicated to helping their readers to manage their finances through providing precise, well-researched and well-understood information that is broken down into complex topics into manageable bites.

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