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What is a precomputed rate auto loan? Advertiser Disclosure Advertiser Disclosure We are an independent, advertising-supported comparison service. Our goal is to help you make smarter financial decisions by offering interactive tools and financial calculators that provide objective and original content, by enabling you to conduct research and compare information at no cost and help you make informed financial decisions. Bankrate has partnerships with issuers such as, but not restricted to, American Express, Bank of America, Capital One, Chase, Citi and Discover. How We Make Money The products that are featured on this site come from companies that compensate us. This compensation could affect how and when products are featured on the site, such as, for example, the order in which they may be listed within the categories of listing, except where prohibited by law. This applies to our mortgage, home equity and other home loan products. But this compensation does affect the content we publish or the reviews you read on this site. We do not cover the entire universe of businesses or financial deals that could be accessible to you.
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3 min read . Published 17 October 2022
Written by Kellye Guinan. Written by Personal and Business Finance Contributor
Kellye Guinan is a freelance editor and writer with over five years of experience in personal finances. She’s also a full-time librarian at the local library where she helps her community access information about financial literacy, among other subjects.
The edit was done by Rhys Subitch Edited by Auto loans editor
Rhys has been writing and editing for Bankrate since the end of 2021. They are passionate about helping readers gain the confidence to take control of their finances through 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 rates on an auto loan that is beneficial to the lender. Rather than spread the interest out throughout the duration of the loan it is front-loaded — meaning that you pay more in than you would at the beginning of the loan and less at the conclusion. If you make minimum payments it is not a difference between the precomputed interest auto loans. You will get some money back if you pay off the auto loan early however, it’s smaller than that of a regular auto loan. How a precomputed interest auto loan operates “Precomputed” means the lender determines the amount of interest that you’ll be paying over the loan term. Then, it adds that interest to the principal and divides it into monthly payments like traditional auto loans which use simple interest. The method of calculating interest benefits lenders if you repay early. They’re not as popular as regular interest loans. You are more likely to find them offered by buy-here-pay-here dealers as well as other lenders who work on behalf of bad credit borrowers. Due to this, they are more likely to charge higher interest rates. You’ll receive the interest rate along with an annual percentage rate that includes any additional charges. Precomputed interest in comparison to. simple interest. While precomputed interest is a way to front load what you pay you, it is possible to split the interest equally. Paying over the amount of your monthly amount cuts down on the principal, which, in turn, results in a lower interest rate in the following month. If you only make the minimum payment then there will be no difference between these two ways to calculate interest. But if you plan to make an effort to repay your auto loan in a short time, then simple interest loans are the best choice. The rule of 78 Lenders are not legally allowed to charge you interest that hasn’t been accrued. However, they are able to alter how interest is distributed across the course of a loan. The rule of 78 alters how you but do not affect the total amount you pay. This is among the most popular methods — and is the basis for precomputed auto loans. Loan lenders add up all months of the year, which is 78, and then apply interest in reverse order. In the course of a one-year loan it is possible to have to pay 12/78 percent of total amount due in the first month. The second month will be 11/78, the third month is 10/78 and the cycle continues. This means that you’ll have to have to pay more in the beginning and end of the loan. There is a chance to get a refund on interest if you repay your loan early, though you will not save as much as you could with a standard interest loan. Some states have banned rules like 78 -and it’s prohibited for loans lasting 61 months or longer. Be sure to check your state’s laws to ensure that your lender isn’t offering you an unconstitutional loan. What is the method by which interest refunds are calculated for precomputed interest auto loans? The refunds can be calculated as a result of subtracting the interest you have previously paid off from remaining interest on your loan. However, since the interest is frontloaded — you pay a greater portion at the beginning of the loan and you’ll be able to receive less in the time you take to complete the repayment of your loan. For instance, you’ll pay around $4,800 of interest on an $30,000 loan with a 60-month repayment term with a 6 percent interest rate. If you pay your loan two years early then the lender will add up 3 years of interestmultiplying 78 times three to arrive at 234 then divide this number by 390 which is the rule of 78 divided over five years. The lender will have made 60 percent of its interest by this moment. Therefore, you’ll receive a refund for the remaining 40 percent — totaling $1,920. Benefits and drawbacks of precomputed rates of interest Precomputed rate of interest is not a problem when you wish you to settle your loan in advance. In any other case, it will cost you exactly the same as a simple interest loan. Benefits Since precomputed interest is beneficial to the lender it is most likely to be provided to those who have less than perfect credit. If you don’t qualify for a basic interest auto loan but you might be eligible for precomputed interest loan. There’s no difference in the amount of interest that you pay on a precomputed interest auto loan. If you follow the minimum payment schedule and you are able to calculate the interest, a precomputed loan is like a standard interest loan.
Cons The major drawback with precalculated interest is the possibility of early repayments. It is more expensive to pay interest if you repay your loan in advance that means less savings to be financially responsible. Since lenders can only use the 78 rule for loans that are sixty months and less, it is possible that you might be paying more monthly. If you’re only qualified for a precomputed interest auto loan and you are not eligible for precomputed interest auto loans, your loan may be more expensive from month to month.
Why you should avoid precomputed interest automobile loans In general simple interest is the best option for almost every borrower. Even if you don’t have plans to pay back your loan in the near future the situation may change. In the event that it does, a straightforward interest loan can mean you’ll pay less overall. Since you pay higher interest at the start of an auto loan, you’ll miss savings if pay off your loan in a timely manner. It could be an insignificant variation, but it’s your money. The lower the amount you must pay your lender, the more favorable. The bottom line is that precomputed auto loans are avoidable however, they’re not the worst thing when you plan to pay minimum monthly payments. But, it is important to locate more lenders and potentially a better deal.
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Written by a Personal and Business finance contributor
Kellye Guinan is a freelance editor and writer with over five years ‘ experience within personal financial matters. She also works full-time as a librarian at the local library which she assists her local community to get information about financial literacy, among other subjects.
Edited by Rhys Subitch Edited by Auto loans editor
Rhys has been editing and writing for Bankrate since the end of 2021. They are committed to helping readers gain the confidence to control their finances by providing concise, well-studied information that is broken down into complicated subjects into digestible pieces.
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