Investopedia explains Rule Of 78 as below:
* When paying off a loan, the repayments consist of two parts: the principal and the interest charge.
* The Rule of 78 weights earlier payments with more interest than later ones. If the loan is not terminated or prepaid early, the total interest paid between simple interest and the Rule of 78 will be equal.
* However, because the Rule of 78 weights the earlier payments with more interest than a simple interest method, paying off a loan early will result in the borrower paying more interest overall.
History of Rule 78
* The earliest official use of the Rule of 78s to calculate the unearned portion of a loan’s finance charge was in Indiana in 1935. Most loans then were for small amounts at low interest rates for short period like 12 months during the pre-computer era.
* The number 78 is actually the sum of 1 to 12 (1+2+3…..+11+12 = 78).
* Assuming a 12 month loan with interest of $1,000,
1st month – 12/78 x $1,000 = $153.85 will be your payment on this interest,
2nd month – 11/78 x $1,000 = $141.02 will be your 2nd month payment on this interest
12th month – 1/78 x $1,000 = $12.82 to be your 12 months payment on this interest.
This Singapore Case
* This rule 78 normally applies to Car loans where early settlement of the loan will entitle you to a rebate on the interest, calculated using this “Rule of 78” formula. Read more…