Rebate to Avoid - 'Rule of 78'
Most rebates are good for the
consumer, and will save you money. However not all rebates are
beneficial. In fact, there is a rebate called 'Rule of 78' that is
tricky and actually represent a prepayment penalty.
What is the 'Rule of 78'?
There are two
types of auto loans: simple interest loans and pre-computed
loans. The Rule of 78 is a
pre-computed loan. This means that the interest you are going to
pay for your car loan is predetermined and that you are obligated
to pay the entire amount of interest even if you pay your loan off
A simple-interest loan is very
different. You are only charged interest based on the amount that
you owe, for the time that you owe. When you pay ahead on your
loan, you save money on interest. There are no prepayment
When you pay ahead on a loan that applies the "Rule of 78s" method
to prepayments you will be hit with a prepayment penalty, that
will be disguised as a rebate.
Paying off your loan early
When you pay off your pre-computed loan early, you are going
to be in for a big surprise. Lets says you settle your 48 month
loan in 36 months. You expect to save money in interest right?
Wrong! When the loan provider calculates what you owe by mean of
the Rule of 78, you will owe more. This is because your lender
will apply more of your previous payments to interest, and less to
principal. So, since less has been applied to principal, you are
going to owe more in principal when you look to settle your car
Rule of 78 is illegal in some states
Below is a list of states that do not allow the use of the
Rule of 78s formula in car loans of five years and less:
Lenders that issue pre-computed loans
that utilize the Rule of 78 formula are rare. However, if you have
less than perfect credit, you should be aware that some lenders
still grant pre-computed Rule of 78s auto loans. Note that
Premier Auto Financing never issues pre-computed loans to anyone!
Another dealership trick to watch out
for is 0% financing.
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