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What is a precomputed rate auto loan? Advertiser Disclosure Advertiser Disclosure We are an independent, advertising-supported comparison service. Our goal is to help you make better financial choices by offering interactive financial calculators and financial tools, publishing original and objective content. We also allow you to conduct your own research and compare data for free to help you make financial decisions with confidence. Bankrate has agreements with issuers, including but not limited to American Express, Bank of America, Capital One, Chase, Citi and Discover. How We Earn Profit The products that are featured on this website are provided by companies who pay us. This compensation may impact how and when products are featured on this website, for example for instance, the order in which they may be listed within the categories of listing in the event that they are not permitted by law. Our loan products, such as mortgages and home equity, and other home lending products. This compensation, however, does have no impact on the content we publish or the reviews you read on this site. We do not include the vast array of companies or financial deals that could be accessible to you.
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3 min read . Published October 17, 2022
Authored 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 librarian at the local library where she helps her community 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 the confidence to control 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 the interest rate on an automobile loan which benefits the lender. Instead of spreading the interest evenly out over the life of the loan, the interest is front-loaded — meaning that you pay more in rate at the start of your loan and less towards the end. If you only make the minimum payments it is not a difference between pre-calculated auto loans. You can get some cash back if you pay off the auto loan in advance however, it’s less than with a simple auto loan. How a precomputed interest auto loan operates “Precomputed” means that the lender calculates the amount you’ll pay over the loan duration. It then adds the amount to your principal, and splits it into monthly payments like regular auto loans which use simple interest. The method used to calculate interest favors lenders when you pay early. They aren’t as common as regular interest loans. They are more likely to find them offered by buy-here-pay-here dealers as well as other lenders who are working in conjunction with bad credit borrowers. Due to this, they tend to have higher interest rates. You’ll receive an interest rate and an annual percentage rate, which also includes any additional fees. Precomputed interest vs. simple interest. Precomputed interest charges you upfront you, it is possible to split the interest equally. Making more than the minimum reduces the principal, which will mean you pay less interest each month. If you just make the minimum amount of payment, there won’t be a distinction between these two methods to determine interest. But if you plan to make an effort to repay your auto loan in a short time, then simple interest loans are the best choice. It is a rule of law that says 78. Lenders aren’t legally permitted to charge interest that hasn’t accrued. However, they are able to alter the method of dividing interest across a loan. A rule called 78 changes the way you pay, but do not affect the amount you pay. The is one of the main strategies — and also the basis for precomputed auto loans. Lenders add up all the months in the year, which add up to 78, then apply interest in reverse order. In a one-year loan it is possible to have to pay 12/78 percent of total interest due in the first month. The second month will be 11/78, the 3rd month is 10/78, and the cycle continues. That means that you’ll have to pay more in the beginning the term of your loan. You may be eligible for a discount on interest if you take care to pay off your loan earlier, however you will not save as much than you could with a standard interest loan. Some states have banned the rule of 78and it’s illegal for loans that last 61 months or longer. Be sure to check your state’s laws to ensure that your lender doesn’t offer you the wrong loan. How is an interest refund calculated for precomputed auto loans? They are calculated using subtracting interest you’ve previously paid off from interest remaining on the loan. But because the interest is frontloaded -that is, you pay a larger amount at the beginning of the loan and you’ll have less refunded the longer you wait to complete the repayment of the loan. As an example, you’ll pay around $4,800 of interest for a $30,000 loan with 60-month term of repayment with a 6 percent interest rate. If you repay your loan two years early it will be a two-year loan. The lender will add all three of the years -multiplying 78 by 3 to get 234 — then divide this number by 390 which is the standard of 78 divided over five years. The lender has made 60 percent of its interest by this moment. Therefore, you’ll receive an amount of refunding the remaining 40 percent — totaling $1,920. Benefits and disadvantages of precomputed interest Precomputed interest is not a problem when you wish to pay off your loan in advance. Otherwise, it will cost you exactly the same amount as a regular interest loan. Pros Because precomputed interest benefits the lender and the lender, they are more likely to be granted to borrowers with less-than-perfect credit. If you don’t qualify for a simple interest auto loan but you might be eligible for an interest-only precomputed loan. There’s no difference in the amount of interest that you pay for an auto loan. If you adhere to the minimum repayment schedule, a precomputed interest loan is precisely identical to a regular interest loan.
Cons The main drawback of precomputed interest is early payments. You’ll pay more interest if you repay your loan earlier and this means you will have lower savings and less responsible. Because lenders are limited to using the 78 rule for loans that are 30 months or more, you may pay more in monthly installments. If you are only eligible for a precomputed auto loan, your loan might be more costly in the month.
Why you should avoid automated interest-based automobile loans In general straightforward interest rates are the ideal choice for nearly every borrower. Even when you don’t plan to pay off your loan at a later date it is possible that your situation will change. In the event that it does, a straightforward interest loan will mean you pay lower overall. Because you pay more in interest when you first take out an auto loan you’ll be missing savings if make a payment in a timely manner. This may be just an insignificant difference, but it’s still your money. The less you need to pay your lender the less you pay, the better. The bottom line Precomputed interest auto loans are avoidable however they are not a bad 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 who has more than five years ‘ experience within personal financial matters. She is also a full-time librarian at the local library in which she assists the 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 to manage their finances with precise, well-researched and well-understood information that is broken down into complicated topics into bite-sized pieces.
Auto loans editor
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