Legal Definitions - rule of 78

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.