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How to Calculate a Car Loan - Beware of the Rule of 78s
Before you apply for a
car loan, it helps to get an idea on
how to calculate a car loan's interest, along with all the other payments you have to make with regards to your loan. Be knowledgeable on the different
financial formulas used by
car loan companies, so that you don't get fooled.
How to Calculate a Car Loan - Don't Get Hooked with A Pre-Computed Loan
The Rule of 78s is a
formula used for computing the rebate of
finance charges when a borrower pays off his loan early. Also termed as the sum-of-the-digits method, it was a
formula devised in the 1920s and 1930s as a quick way for estimating the payoff amounts when the borrower pays off early on a loan. Its name comes from the summation of the numbers 1 to 12, the number of months in a year.
A
car loan can either be a simple interest loan or a pre-computed loan. The Rule of 78s is used with pre-computed
car loans whenever a borrower pays the amount of the
car loan early. With a pre-computed loan, the total amount of interest that will be accumulated during the entire life of the loan is calculated at the onset, and once you've signed up for the
car loan, you're obliged to pay for the principal amount of the loan plus the interest.
However, when you decide to pay early for your
car loan, you are bound to get charged more than what is right no matter how much sweet talking your lender does. By applying the Rule of 78s, the
car loan company applies more of your previous payments to the interest rather than to the principal. Since less is applied to the principal, it follows that the remaining balance for your loan is higher than expected. In addition, the earlier you pay off and the higher the interest rate, the higher you'll get charged.
This is contrary to a simple interest
car loan where the interest is computed based on the remaining balance, so the earlier you pay, the lesser interest you'll be charged. Moreover, there are some
car loan companies that even reward borrowers for paying off their loan early.
Written by: Mika Villanueva See our reviews for more on [ how to calculate a car ]
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