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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 over 5 years experience working in the field of personal financial matters. She is also a full-time librarian at the local library where she helps her community gain access to information on financial literacy, in addition to other topics.

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 passionate about helping readers gain the confidence to take control of their finances by providing clear, well-researched information that breaks down otherwise complex subjects into bite-sized pieces.

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Precomputed interest is an uncommon method of calculating the the interest rate on an automobile loan which benefits the lender. Instead of dispersing the interest equally over the course of the loan, the interest is a front-loaded one, which means you pay more interest at the beginning of the loan and less towards the end. If you pay the minimum amount it is not a difference between and precomputed interest auto loans. You can get some cash back if pay off the auto loan in advance however it’s smaller than that of a regular interest auto loan. How a precomputed interest auto loan works “Precomputed” means that the lender determines the amount of interest that you’ll be paying over the loan duration. It then adds the rate of interest on top of the principle amount and divides it into monthly payments, similar to traditional 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. You are more likely to find them offered by buy-here-pay-here dealers and other lenders that deal in conjunction with bad credit borrowers. Because of this, they are more likely to charge very high interest rates. You’ll receive the interest rate along with an annual percent rate which includes any additional charges. Precomputed interest in comparison to. simple interest While precomputed interest charges you upfront, split the interest paid evenly. Making higher than your minimum payment decreases the principal, which, in turn, means you pay less interest each month. If you make only the minimum amount of payment then there will be no distinction between these two methods to determine interest. However, if you are planning to make an effort to repay your auto loan quickly, simple interest loans are the best option. The rule of 78 Lenders are not legally allowed to charge interest that hasn’t accrued. However, they are able to alter how interest is distributed across the duration of a loan. A rule called 78 alters the way you pay, but do not affect the total amount you have to pay. It is among the principal methods — and is the basis for precomputed auto loans. Loan lenders add up all months of the year which is 78, and the interest is then applied in reverse. During a one-year loan it is possible to be paying 12/78 on the total interest due in the first 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 and end of the loan. You may be eligible for a discount on interest if you take care to pay off your loan in advance, but you won’t save as much than you would with an interest loan. Some states have banned the rule of 78 -and it’s unlawful for loans lasting 61 months or longer. Examine the laws of your state to ensure that your lender doesn’t offer you an unconstitutional loan. What is the method by which interest refunds are calculated for precomputed auto loans? The refunds can be calculated as a result of subtracting the interest you have been paying from interest remaining on the loan. But because the interest is frontloaded -which means you pay a higher portion at the beginning of the loan the loan is paid off. You will have less refunded the longer you take to complete the repayment of your loan. For example, you will pay around $4,800 of interest on the $30,000 loan with 60-month term of repayment and a 6 percent interest rate. If you repay your loan two years in advance, the lender will add 3 years of interestmultiplying 78 times three to get 234 — then divide that number by 390, which is the standard of 78 spread across five years. The lender has received 60 percent of the interest by this moment. This means you’ll get an amount of refunding the remaining 40 percent , totalling $1,920. Benefits and drawbacks of precomputed interests Precomputed interest is only an advantage if you want be able to repay your loan early. In any other case, it will cost you the same as a simple interest loan. Benefits Since precomputed interest is beneficial to the lender it is more likely to be offered to those with less than perfect credit. If you don’t qualify for a simple interest auto loan however, you could still be eligible for an interest-only precomputed loan. There is no difference in the amount of interest you pay for an auto loan. If you stick to the minimum payment plan, a precomputed interest loan is exactly the same as a simple interest loan.

Cons The main drawback of precomputed interest is early payments. You will pay more in interest if you repay your loan early, which means less savings to be financially responsible. Since lenders are only able to apply the 78-day rule on loans with terms of sixty months and less, it is possible that you could pay more in monthly installments. If you only qualify for a precomputed auto loan then your loan might be more costly between months.

Why you should avoid precomputed interest car loans In general simple interest is the ideal option for almost every borrower. Even if you don’t have plans to pay off your loan early now the situation may change. If it does, a simple interest loan will mean you pay less in total. Since you pay higher interest at the start of an auto loan you’ll be missing the savings if you pay off your loan early. This may be just a small difference, but it’s still your money. The less you need to pay your lender and the lower your monthly payments, the better. The bottom line is that precomputed auto loans can be avoided however they are not the worst thing when you plan to make minimum payments. Still, you should to locate more lenders and possibly a better rate.

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Written by a Personal and Business finance Contributor

Kellye Guinan is a freelance editor and writer who has more than 5 years experience working in the field of personal finance. She is also a full-time worker at her local library where she helps her community access information about financial literacy, as well as other subjects.

Editor: Rhys Subitch Edited by Auto loans editor

Rhys has been writing and editing for Bankrate since the end of 2021. They are dedicated to helping their readers gain the confidence to manage their finances by providing concise, well-studied information that breaks down otherwise complex topics into manageable bites.

Auto loans editor

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