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What is a precomputed interest auto loan? Advertiser Disclosure Advertiser Disclosure We are an independent, advertising-supported comparison service. Our mission is to help you make smarter financial decisions by providing you with interactive financial calculators and financial tools that provide objective and original content, by enabling you to conduct your own research and compare information at no cost – so that you can make sound financial decisions. Bankrate has agreements with issuers such as, but not limited to American Express, Bank of America, Capital One, Chase, Citi and Discover. How We Earn Money The deals that are advertised on this site are from companies that pay us. This compensation may impact how and where products appear on this site, including such things as the order in which they may appear within the listing categories in the event that they are not permitted by law for our mortgage, home equity and other products for home loans. However, this compensation will affect the information we publish, or the reviews you see on this site. We do not contain the universe of companies or financial offerings that could be open to you.
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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 more than 5 years experience working in the field of personal finances. She is also a full-time worker at her local library which she assists her local community to access information about financial literacy, in addition to other topics.
Edited by Rhys Subitch Edited by Auto loans editor
Rhys has been editing and writing for Bankrate since late 2021. They are committed to helping readers gain confidence to manage their finances through providing clear, well-researched information that breaks down otherwise complex topics into digestible chunks.
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Precomputed interest is an uncommon way of calculating interest on an auto loan that is beneficial to the lender. Rather than spreading the interest evenly out throughout the duration of the loan the interest is a front-loaded one, which means that you pay more in interest at the beginning of the loan and less at the end. If you make minimum payments it is not a difference between pre-calculated auto loans. You can get some cash back if you repay the auto loan early, but it will be lower than a standard interest auto loan. The way a precomputed interest auto loan functions “Precomputed” means that the lender calculates the amount that you’ll be paying over the loan duration. Then, it adds that interest to the principal amount and divides it into monthly installments as with regular auto loans that use simple interest. The way interest is calculated is advantageous to lenders if you are able to pay early. They aren’t as common as simple interest loans. It is more likely that you will find them offered by buy-here-pay-here dealers as well as other lenders who work on behalf of bad credit borrowers. Because of this, they tend to have higher interest rates. You’ll receive an interest rate as well as an annual percentage rate which also includes any additional fees. Precomputed interest in comparison to. simple interest While precomputed interest charges you upfront divide the interest evenly. Paying higher than your minimum payment reduces the principal amount, which will mean you pay less interest in the following month. If you just make the minimum amount, there won’t be a distinction between the two methods to determine interest. If you intend to pay off your auto loan quickly, simple interest loans are the best choice. It is a rule of law that says 78. Lenders are not legally allowed to charge interest that isn’t earned. However, they are able to alter the way interest is divided throughout a loan. This rule can alter the way you pay, but do not affect the total amount you pay. This is among the principal strategies — and also the foundation for precomputed interest auto loans. Lenders add up all the months of the year, which add up to 78, the interest is then applied in reverse. During the course of a one-year loan it is possible to have to pay 12/78 percent of interest due in the initial month. The second month would be 11/78, and the third month is 10/78 and the cycle continues. This means that you’ll have to pay more at the start the term of your loan. You may be eligible for a discount on interest when you pay off your loan earlier, however you won’t save as much as you would with an interest loan. Some states have banned the rule of 78in addition, it’s illegal for loans lasting at least 61 months. Examine the laws of your state to ensure your lender isn’t offering you an illegal loan. What is the method by which interest refunds are calculated for precomputed auto loans? Refunds are calculated by subtracting interest you have been paying from balance of interest on your loan. However, since the interest is frontloadedwhich means you pay a higher part at the start of the loan the loan is paid off. You will have less refunded the longer you have to complete the repayment of the loan. For example, you will pay around $4,800 of interest on the $30,000 loan with 60-month repayment terms and a 6-percent interest rate. If you pay your loan two years early it will be a two-year loan. The lender will add up the first three yearsmultiplying 78 times three to come up with 234 then divide the result by 390, that’s the principle of 78 divided over five years. The lender will have earned 60 percent of its interest by this point. So you will receive a refund for the remaining 40 percent , totalling $1,920. Benefits and drawbacks of precomputed interests Precomputed interest is not a problem when you wish be able to repay your loan in advance. In any other case, it will cost you the same as a standard interest loan. Advantages: Since precomputed interest favors the lender it is much more likely to get provided to borrowers with less-than-perfect credit. If you’re not eligible for a simple interest auto loan, you may still be approved for precomputed interest loan. There is no difference in how much interest you pay with an auto loan. If you stick to the minimum repayment schedule and you are able to calculate the interest, a precomputed loan is like a standard interest loan.
Cons The biggest drawback to precalculated interest is that it can lead to early payments. It is more expensive to pay interest if you repay your loan early that means less savings to be financially responsible. Since lenders are only able to apply the rule of 78 on loans that have terms of 60 months or less, you might be paying more monthly. If you’re only qualified for a precomputed auto loan, your loan might be more costly from month to month.
The reasons to avoid precomputed interest auto loans In general, simple interest is the better option for most borrowers. Even even if you’re not planning to repay your loan in the near future 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 interest when you first take out an auto loan and you’ll lose the savings if you pay off your loan in a timely manner. It could be an insignificant difference, but it’s still your money. The lower the amount you must 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. Still, you should to find more lenders — and, if you are lucky, 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 ‘ experience within personal finance. 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 topics.
Editor: Rhys Subitch Edited by Auto loans editor
Rhys has been writing and editing for Bankrate from late 2021. They are dedicated to helping their readers feel confident to manage their finances through providing precise, well-researched and well-understood information that is broken down into complex topics into manageable bites.
Auto loans editor
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