help with "rule of 78" loan calculation?

crazykazoo@hotmail

Hi,

I am new to this website and it seems very good. However, as I was browsing through, I clicked onto a link which sent me to the loans page.

My partner recently applied for a Tesco loan - £15,000 over 10 years at 9.6%. He wants to pay the loan back within the next 3 years and was told that there would be a 2 month interest penalty for doing this.

This seemed fine, until I read about the "rule of 78" calculation on this website. It has got me slightly worried about how much my partner will end up paying back. He phoned Tesco and they said yes, they do use the "rule of 78", but they couldn't tell him how much he would end up paying back until he put in a request to settle early.

I also read that in 2007, existing loan holders will not have to worry about this rule anymore?

Sorry if I sound a bit muddled, but I just thought I would check to see if anybody had any further info on this as I don't want to end up worrying......

Thanks very much.

Karen.

Debt_Free_Chick

I have a (crude) spreadsheet set up to calculate this.

If you can let me have the amount of interest added to the loan & the monthly instalment from the agreement I can give you a rough figure.

Just to be clear, I need

Amount borrowed
Amount of interest added
Term of loan
Monthly repayment

I assume he did not take the payment protection insurance? If he did, I need the amount of the premium and the interest added to that, too.

Cheers

Robert_Sterling_3

If all you have to do is pay an extra two months interest you will be laughing as compared with if you add two months to the time you have actually held the loan for AND then they operate the Rule of 78 on the rebate of interest.  The Rule of 78 calculation is the harshest way a lender can claim interest.  They do not have to use the Rule of 78 if they are willing to do better than the Rule of 78 requires.

If the total Interest Due on the loan over 10 years is I
then the rebate of interest is

I * m*(m-1)

---

     n*(n-1)

Where m is the number of months of the loan remaining
and n is the total number of month of the loan.

So as an example in this case n = 120 months.
If you are three years ,  36 months , into the loan
The months remaining, m, is 120-36 = 84 months ( 7 years )
Now Tesco can claim two additional months
So m will be not 84 but 82

So the rebated interest is

I * 82 * 81

---

   or approx  46.5% of I
   120 * 119

The total interest to be paid, I, should be set out clearly  on the loan agreement

If you are 3 years into a 10 year loan then the interest
rebated on early redemption with 2 months added is about 46.5% of the initial total interest due.


The rule of 78 is set out in the Consumer Credit Act of 1975.

A review of the Consumer Credit Act has taken place recently.

This may result in amendments to the Act.

For what it is worth, nothing you may well think, my view is that the legislation to alter the Consumer Credit Act will not be enacted before the next general election and even when and if it is altered the Rule of 78 may well remain.  The customer signs up for a Fixed Rate Loan and then wants to call it off early.  In any other area of activity this would be breach of contract and the repayment of the loan would be legally enforceable.
The Consumer Credit Act has tried for nearly 30 years to offer a compomise which is acceptable to both the lender & the borrower.  Without the rule of 78 lenders will not be so ready to lend to non status borrowers.  This could be a mixed blessing.

This is not financial advice nor is it legal advice.

funkymonkey

Paid off a debenhams loan early last week. Was on month 7 of a 4year term of 5000 @ 16.9% had a bonus from work so paid it off early but my setlement figure was 4,920.14 after paying 140 pounds for 7 months! i cant believe that these companies are aloud to do such a thing!

Robert_Sterling_3

A calculation based on not being in possession of all the facts. i.e. Not a calculation of your actual loan but how I would have calculated the redemption figure if I was to lend you money as follows.

Loan  £5000
60 payment of 140 required in 60 months  £8400

Interest  I  =  £8400- £5000 =  £3400

Repaid  7 * £140  =  £980

Rebate of Interest   3400 * 51*50
                               

---

    =    £2449
                                   60*59

Balance due  

£8400 -£980  - £2449  =  £4971


My calculation is based on the use of the Rule of 78 taking the 2 extra months allowed by the Consumer Credit Act.  I get a slightly different figure if I only take one extra month rather than 2.


Since the Consumer Credit Act of 1975 has been in force it has been subject to a number of revisions and updates.  The rule of 78 has survived so far for 30 years.

You may be surprised to hear that the redemption figure in the first few months of a long term loan can exceed the initial amount borrowed.  I will not go into the mathematical details here.




This is not legal or financial advice.
It acually confirms that the redemption figure is likely to be spot on in so far as one can judge on the basis of incomplete information..

crazykazoo@hotmail

Hi,

The amount borrowed is £15,000
The amount of interest added is £7,000
The term of the loan is 10 years
The monthly repayments are 120 payments at £189 per month.

Lucky enough, he didn't take payment protection.

Cheers.

*k*

Robert_Sterling_3

You say that the amount of the loan was  £15000
The amount of interest was  £7000

The Total Repayment is  120 months at £189 = £22680

So an additional  £680 has found its way into the calculation.

Let us carry on regardless and being aware that I will produce a "ball park" figure based on insufficient information.


OK

After 3 years you will have made 36 payments of  £189

i.e.  £6804

Then add two to 36 to get  38 months thus the number of months remaining when calculating the interest rebate m will be 120 - 38  =  82

So Rebate of interest is

I *  82 * 81

---

    120 * 119

I will take I to be £7000 for the purpose of this calculation

So the rebate is   £7000 * 82 * 81
                           

---

 =  £3255.88
                                     120 * 119


You are actually rebated about  46.5% of the interest

i.e.  You are not rebated the other  53.5% of the interest.

So although you are 30% of the way through the loan
You actually pay  53.5% of the interest.

Those people who have a repayment mortgage over 25 years are often surprised at the large proportion of their monthly payment that is interest and the small amount of capital which is paid in the early years.

So to the redemption figure

Total owed

£22680

Paid

36 * £189  =   £6804

Rebated     =   £3256

Total               £10,060

Settlement Figure

£22,680 -  £10,060   =  £12,620.


This is not legal or financial advice.
It is a calculation based on numbers provided, which are in themselves inconsistent, and the Rule of 78 formulae provided in the Consumer Credit Act of 1975.

crazykazoo@hotmail

So it works out that my partner will pay roughly £19,000 back in total.

That's very useful Robert - thanks very much!    

*k*

Robert_Sterling_3

Cheers.

ffs

Your lender will tell you that they have to charge you interest as set out by "rule of 78" if you redeem early. Of course they are misleading you, in fact this is the maximum they are permitted to charge under consumer credit legislation, but this is never the way they present it.

Thanks to RS for the sample calculations.

Robert_Sterling_3

Thank You F F S