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Simple English definitions for legal terms
rule of 78
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A quick definition of rule of 78:
The rule of 78 is a way to figure out how much money someone can save by paying off a loan early. This is especially helpful when the loan has higher interest payments at the beginning. To use the rule of 78, you add up the numbers for all the remaining payments and divide that by the total of all the payments. Then you multiply that percentage by the total interest. This helps people see how much money they can save by paying off their loan early.
A more thorough explanation:
The rule of 78 is a method used to calculate the amount of interest a borrower can save by paying off a loan early. This method is used when the interest payments are higher at the beginning of the loan period.
For example, if a borrower has a 12-month loan and decides to pay it off after 6 months, the rule of 78 can be used to determine how much interest they will save. To do this, the sum of the digits for the remaining six payments (21) is divided by the sum of the digits for all twelve payments (78). The resulting percentage is then multiplied by the total interest.
Here's an example:
A borrower takes out a $10,000 loan with a 12-month term and an interest rate of 10%. The total interest on the loan is $1,000. After making six payments, the borrower decides to pay off the loan early. Using the rule of 78, the borrower can calculate how much interest they will save:
- Sum of digits for remaining six payments: 21
- Sum of digits for all twelve payments: 78
- Percentage of interest saved: 21/78 = 0.2692
- Interest saved: $1,000 x 0.2692 = $269.20
This means that by paying off the loan early, the borrower will save $269.20 in interest.
The rule of 78 can be a useful tool for borrowers who want to save money on interest payments. However, it's important to note that not all loans use this method of calculation, and some lenders may charge prepayment penalties for paying off a loan early.