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3 minutes read. Published 17 October 2022

Written by Kellye Guinan. Written by personal and Business Finance contributor

Kellye Guinan is a freelance editor and writer with more than 5 years experience working in the field of personal finances. She’s also a full-time worker at her local library which she assists her local community to access information about financial literacy, among other subjects.

Editor: Rhys Subitch Edited by Auto loans editor

Rhys has been writing and editing for Bankrate since the end of 2021. They are passionate about helping readers gain the confidence to manage 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 unique method of calculating the interest rate on an automobile loan which benefits the lender. Instead of dispersing the interest equally throughout the duration of the loan, the interest is front-loaded — meaning you pay higher than you would at the beginning of the loan and less towards the end. If you only make the minimum payments and do not make any distinctions between the precomputed auto loans. There is a chance to get some money back if you pay off the auto loan early however it’s less than with a simple interest auto loan. What is a precomputed auto loan works «Precomputed» means the lender determines the amount of interest that you’ll be paying over the loan term. Then, it adds that interest to the principal and divides it into monthly installments, similar to standard auto loans that use simple interest. The way interest is calculated benefits lenders if you repay early. They’re not as popular as traditional interest loans. They are more likely to get them from buy-here-pay-here dealers and other lenders that work with bad credit borrowers. This is why they tend to have higher interest rates. You’ll receive the interest rate along with an annual percentage rate which includes any additional charges. Precomputed interest in comparison to. simple interest. Precomputed interest charges you upfront divide the interest equally. Making over the amount of your monthly decreases the principal, which in turn means you pay less interest in the following month. If you just make the minimum payment, there won’t be a distinction between the two methods to determine interest. If you intend to pay off your auto loan quickly, interest-only loans are the best choice. This is the rule that applies to 78. Lenders are not legally allowed to charge interest that isn’t earned. However, they may alter how interest is distributed across the course of a loan. This rule alters how you but not the total amount you have to pay. The is among the most popular methods — and is the foundation for precomputed interest auto loans. The lenders add all the months of the year which is 78, and then apply interest in reverse order. For an one-year loan you’d have to pay 12/78 percent of total interest due in the first month. The second month would be 11/78, and the third month is 10/78, and on and so forth. This means that you’ll have to have to pay more in the beginning the term of your loan. You may be eligible for a discount on interest when you pay off your loan earlier, however it won’t be as effective as you would with an interest loan. Some states have banned rules like 78in addition, it’s prohibited for loans that last more than 61 months. Check your state’s laws to ensure your lender isn’t offering you the wrong loan. What is the method by which interest refunds are calculated for precomputed auto loans? They are calculated using subtracting the amount of interest you have already paid from the balance of interest on your loan. However, since the interest is frontloaded -which means you pay a higher amount at the beginning of the loan — you will be able to receive less in the time you have to complete the repayment of the loan. As an example, you’ll pay about $4,800 in interest for a $30,000 loan with 60-month term of repayment and a 6-percent interest rate. If you pay off your loan two years early it will be a two-year loan. The lender will add 3 years of interest- multiplying 78 by three to arrive at 234 then divide that number by 390, which is the rule of 78 spread across five years. The lender will have earned 60 percent of its interest at this moment. This means you’ll get a refund for the remaining 40 percent , totalling $1,920. Benefits and drawbacks of precomputed rates of interest Precomputed rate of interest is only an advantage in the event that you need be able to repay your loan in advance. Otherwise, it will cost the same as a standard interest loan. Benefits Since precomputed interest is beneficial to the lender it is more likely to be granted to borrowers with less-than-perfect credit. If you’re not eligible for a basic interest auto loan but you might be eligible for a precomputed interest loan. There is no difference in how much interest you pay with an auto loan. If you stick to the minimum payment plan and you are able to calculate the interest, a precomputed loan is the same as a simple interest loan.

Cons The main drawback of 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. Since lenders are only able to apply the 78-day rule on loans with terms of 60 months or less, you could have higher monthly payments. If you only qualify for a precomputed interest auto loan then your loan could be more expensive from month to month.

The reasons to avoid automated interest-based auto loans In general straightforward interest rates are the better choice for nearly every borrower. Even if you don’t have plans to pay back your loan in the near future, your situation could change. And if it does, a straightforward interest loan can mean you’ll pay less in total. Because you pay more in interest at the start of an auto loan and you’ll lose savings if pay off your loan early. It could be only a tiny difference, but it’s your money. The less you have to pay your lender and the lower your monthly payments, the more favorable. The bottom line Precomputed auto loans can be avoided however they are not the worst thing for those who only intend to pay minimum monthly payments. However, you must look for more lenders and potentially 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 of experience in personal finances. She’s also a full-time worker at her local library in which she assists the community get information about financial literacy, in addition to other subjects.

Editor: Rhys Subitch Edited by Auto loans editor

Rhys has been editing and writing for Bankrate since late 2021. They are dedicated to helping their readers gain the confidence to control their finances with precise, well-researched and well-understood information that breaks down complicated subjects into digestible pieces.

Auto loans editor

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