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3 min 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 over five years ‘ experience within personal finances. She is also a full-time employee at the library in her town which she assists her local community to get information on financial literacy, in addition to 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 dedicated to helping readers gain the confidence to take control of their finances with precise, well-studied information that break down complex topics into manageable bites.
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Precomputed interest is an uncommon way of calculating rates on an auto loan which benefits the lender. Rather than spread the interest out over the life of the loan it is front-loaded — meaning you pay more rate at the start of your loan and less at the conclusion. If you only make the minimum payments, there is no difference between the precomputed auto loans. You will get some money back if pay off your auto loan in advance however it’s less than with a simple interest auto loan. What is a precomputed auto loan functions “Precomputed” means the lender calculates the amount you’ll pay over the loan duration. It then adds this amount to your principal amount and splits it into monthly payments like traditional auto loans which use interest that is simple. The method used to calculate interest benefits lenders if you repay early. They’re not as popular as simple interest loans. They are more likely to see them offered by buy-here, pay-here dealers and other lenders that deal on behalf of bad credit borrowers. This is why they are more likely to charge higher interest rates. You will receive an interest rate as well as an annual percentage which includes any additional charges. Precomputed interest is different from. simple interest While precomputed interest is a way to front load what you pay divide the interest equally. If you pay more than the minimum decreases the principal, which in turn results in a lower interest rate each month. If you make only the minimum payment, there won’t be a distinction between the two methods to determine interest. But if you plan to pay off your auto loan in a short time, then simple interest loans are the best option. The rule of 78 Lenders are not legally allowed to charge interest that isn’t earned. But they can change the method of dividing interest throughout a loan. The rule of 78 changes how you pay but do not affect the total amount you pay. This is one of the main tactics — and the basis for precomputed interest auto loans. The lenders add all the months of the year, which total 78, and then apply interest in reverse order. For a one-year loan, you would be paying 12/78 on the total interest due in the first month. The second month would be 11/78, the 3rd month is 10/78 and the cycle continues. This means you will pay more at the start of your loan. You can get a rebate on interest when you repay your loan in advance, but it won’t be as effective as you could with a standard interest loan. Some states have banned using the rule of 78 — and it is nationally unlawful for loans lasting 61 months or longer. Check your state’s laws to ensure your lender doesn’t offer you an unconstitutional loan. How is an interest refund calculated for precomputed auto loans? The refunds can be calculated as a result of subtracting interest you’ve already paid from the balance of interest on your loan. Because the interest is a frontloaded charge — you pay a greater portion at the beginning of the loan — you will receive less money back the longer you have to pay off your loan. As an example, you’ll pay about $4,800 in interest on the $30,000 loan with a 60-month repayment term and a 6-percent interest rate. If you pay off your loan two years in advance it will be a two-year loan. The lender will add the first three years -multiplying 78 by 3 to arrive at 234 then divide this number by 390 which is the rule of 78 divided over five years. The lender has made 60 percent of its interest at this date. 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 a drawback in the event that you need be able to repay your loan in advance. In any other case, it will cost you the same as a simple interest loan. Pros Because precomputed interest benefits the lender and the lender, they are most likely to be granted to those who have less than perfect credit. If you’re not eligible for a standard interest auto loan however, you could still be eligible for a precomputed interest loan. There’s no difference in the amount of interest you pay on the precomputed interest auto loan. If you adhere to the minimum payment plan and you are able to calculate the interest, a precomputed loan is exactly the same as a simple interest loan.
Cons The major drawback with precomputed interest is early payments. It is more expensive to pay interest if you have to pay back your loan earlier that means lower savings and less responsible. Because lenders are limited to using the 78-day rule on loans that are sixty months and less, it is possible that you could pay more in monthly installments. If you are only eligible for a precomputed-interest auto loan and you are not eligible for precomputed interest auto loans, your loan may be more expensive between months.
The reasons to avoid automated interest-based car loans In general simple interest is the best option for almost every borrower. Even when you don’t plan to repay your loan at a later date the situation may change. In the event that it does, an easy 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 out on savings if you pay off your loan early. This may be just an insignificant difference, but it’s your money. The less you have to pay your lender, the better. The bottom line Precomputed auto loans are avoidable, but they also are not the most ideal option when you plan to make minimum payments. But, it is important to look for more lenders and potentially a better deal.
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Written by Personal and business finance contributor
Kellye Guinan is a freelance editor and writer with more than five years ‘ experience within personal finances. She is also a full-time librarian at the local library where she helps her community get information about financial literacy, among other topics.
Edited by 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 gain the confidence to take control of their finances by providing clear, well-researched information that breaks down otherwise complex topics into manageable bites.
Auto loans editor
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