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3 minutes read. Published 17 October 2022

Writer: Kellye Guinan. 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 finance. She also works full-time as a employee at the library in her town where she helps her community gain access to information on financial literacy, in addition to other subjects.

Editor: Rhys Subitch Edited by Auto loans editor

Rhys has been editing and writing for Bankrate from late 2021. They are dedicated to helping readers gain the confidence to take control of their finances by providing concise, well-researched and well-studied content that break down complex topics into manageable bites.

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Precomputed Interest is a rare method of calculating the interest rate on an automobile loan which benefits the lender. Rather than dispersing the interest equally over the course of the loan it is front loaded, meaning that you pay more in rate at the start of your loan and less at the end. If you only make the minimum payments, there is no difference between pre-calculated interest auto loans. You can get some cash back if you repay your auto loan in advance however, it’s smaller than that of a regular interest auto loan. How a precomputed interest auto loan works “Precomputed” is the term used to describe how the lender determines the amount of interest you will pay over the loan period. It then adds this interest to the principal, and divides it into monthly payments as with regular auto loans which use interest that is simple. The method used to calculate interest is advantageous to lenders if you are able to pay early. They’re not as popular as simple interest loans. You are more likely to see them offered by buy-here, pay-here dealers and other lenders that are working on behalf of bad credit borrowers. This is why they tend to have higher interest rates. The rate you pay will be an interest rate and an annual percent rate which also includes any additional fees. Precomputed interest vs. simple interest While precomputed interest front-loads what you pay you, it is possible to split the interest equally. Paying higher than your minimum amount cuts down on the principal, which, in turn, results in a lower interest rate each month. If you just make the minimum amount of payment then there will be no distinction between these two methods to calculate interest. But if you plan to try to repay your auto loan in a short time, then simple interest loans are the better choice. The rule of 78 Lenders are not legally allowed to charge you interest which isn’t earned. But they can change how interest is distributed over the course of the course of a loan. The rule of 78 alters how you but will not impact the total amount you pay. This is one of the main strategies — and also the basis for precomputed interest auto loans. Lenders add up all the months in the year, which is 78, and then apply interest in reverse order. For an one-year loan it is possible to pay 12/78 of the total amount due in the initial month. The second month will be 11/78, the 3rd month is 10/78 and so on. This means you will be paying more at the beginning the term of your loan. There is a chance to get a refund on interest if you take care to pay off your loan early, though you will not save as much than you could with a standard interest loan. Some states have banned using the rule of 78- and it is nationally unlawful for loans lasting at least 61 months. Check your state’s laws to ensure your lender doesn’t offer you an unconstitutional loan. What is the method by which interest refunds are calculated for precomputed interest auto loans? They are calculated using subtracting interest you’ve been paying from balance of interest on the loan. But because the interest is a frontloaded charge — you pay a greater portion at the beginning of the loan the loan is paid off. You will be able to receive less in the time you wait to pay off your loan. For instance, you’ll pay around $4,800 of interest on the $30,000 loan with 60-month term of repayment with a 6 percent interest rate. If you repay 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 come up with 234 then divide this number by 390 which is the standard of 78 spread over five years. The lender has received 60 percent of the interest at this point. Therefore, you’ll receive a refund for the remaining 40%, which is $1,920. Benefits and disadvantages of precomputed interest Precomputed interest is only an advantage when you wish to pay off your loan early. Otherwise, it will cost you the same amount as a regular interest loan. Pros Because precomputed interest benefits the lender it is much more likely to get granted to borrowers with less-than-perfect credit. If you’re not eligible for a basic interest auto loan but you might be approved for an interest-only precomputed loan. There’s no difference in how much interest you pay with a precomputed interest auto loan. If you follow the minimum payment schedule for precomputed interest, the loan is precisely identical to a regular interest loan.

Cons The biggest drawback to precalculated interest is that it can lead to early payments. You will pay more in interest if you repay your loan in advance and this means you will have less savings to be financially 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’re only qualified for a precomputed auto loan then your loan might be more costly between months.

What are the reasons you should stay clear of precomputed interest car loans In general, basic interest will be the best option for most borrowers. Even if you don’t have plans to pay back your loan at a later date it is possible that your situation will change. If it does, a straightforward interest loan will mean you pay less overall. Because you pay more interest in the beginning of a precomputed auto loan you’ll be missing the savings if you make a payment early. It could be only a tiny variation, but it’s 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 can be avoided, but they also are not the most ideal option when you plan to make minimum payments. Still, you should to find more lenders — and potentially a better deal.


Written by a 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 also works full-time as a employee at the library in her town where she helps her community access information about financial literacy, among other subjects.

The edit was done by Rhys Subitch Edited by Auto loans editor

Rhys has been editing and writing for Bankrate from late 2021. They are committed to helping readers to control their finances with clear, well-researched information that is broken down into complicated subjects into digestible pieces.

Auto loans editor

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