RULE 78 : Which lenders use it?

Legacy_user

I'm looking for a loan, But do not want it to be top heavy with interest....as i wish to pay it off early....So how do i find out who is doing rule 78 and who is not ???

sezdav

sorry but im not sure what rule 78 is. could someone briefly explain please. thank you. ???

fiobee

There is a nice explanation here:

http://www.moneyfacts.co.uk/guides/guide_loans.asp#r78

sezdav

thank you fiobee

am much clearer now!! ;D

Rafter

I think rule of 78 is being abolished under the new consumer credit act,  although early repayment penalties of 1 months payments will be allowed.

Moneyfacts do tables of loans and if you click on each one you can see any early repayment penalties.  Only one I could find not charging early repayment or using rule of 78 was Barclays bank although the rate for small loans wasn't that great.

If you have a good credit history a lender like MBNA might give you 9months interest free and you could transfer this to your current account for a charge of £35 or 2% of the amount transferred.  Although you will need to transfer this to another lender in 9 months time you could avoid paying much interest at all?

Good luck

R

Debt_Free_Chick

AFAIK there are very few lenders who don't use Rule of 78 for fixed rate, fixed term personal loans. The key word here is fixed ... you borrow £x and pay it off in a number of instalments. Generally, there's no benefit for paying it off early as all the interest for the entire period has been added upfront. And early instalments go towards paying off more of the interest.

Flexible loans like Cahoot are completely different - more like a revolving overdraft facility. Here, you borrow what you like (up to the limit), when you like. Interest in calculated monthly on the amount outstanding. There's a minimum amount you must repay each month, but you can pay any amount over this and simply pay off the balance when you want.

Interest rates on flexible loans tend to be higher than personal loans. But remember the lack of flexibility with a personal loan. And remember that you only pay interest on the amount outstanding with a flexible loan.

HTH

Robert_Sterling_3

Generally, there's no benefit for paying it off early as all the interest for the entire period has been added upfront. HTH

The above statement is Wrong

Fixed rate loans are either Regulated ( Under £25000) or Unregulated (Over £25000).
The Rule of 78 sets out a formula which is used to calculate the amount of interest which must be rebated by the lender as a % of the total interest which would have been paid if the loan remained in force until the end of the original term of the loan.
If "I" is the full amount of Interest calculated on day 1
and "n" is the number of months of the loan
and "m" is the number of of the loan remaining when early redemption takes place then the amount of Interest rebated is:

I x m x ( m -1) / n x ( n - 1)

In a nutshell this means that if you redeem your loan half way through you still have to pay three quarters of the original amount of interest due.

If the loan is less than £25,000 the lender must use this formula.

If the loan is unregulated i.e. Above £25000 then the lender can require you to pay even more interest.

Robert_Sterling_3

The Consumer Credit Act of 1974 is being reviewed now.
You may contribute your pennyworth to the review any time before 26 November 2004.
It has been reviewed and amended several times in the past 30 years.
The rule of 78 has survived every reveiw so far.
On day one the borrower has signed a contract with the lender.
The lender has spent a considerable sum on advertising and broker's commission etc in setting up the loan.
The Consumer Credit Act has to consider the lender and the borrower.
The borrower is I think in breech of contract if they terminate the loan early. The Rule of 78 compensates the lender for this breech of contract.
As a result of the current review the rule of 78 may go, or may stay, or may be amended.

( This is not legal or financial advice. It is an attempt to put the legal position into laypersons terms. If you need legal or financial advice get it from a professional source )

Debt_Free_Chick

The above statement is Wrong

Actually, it's not. Look at the statement of what is borrowed, which forms part of the loan agreement. There are 2 or 4 amounts

* Amount borrowed
* Interest charged
* Payment protection premium
* Interest charged on payment protection premium

My statement was made of two parts, with the second being

And early instalments go towards paying off more of the interest.

I agree that future interest is rebated, but in the early months, a larger part of the instalment goes towards paying off the interest than in later months.

For example, I have the amortisation schedule for a 60 month loan, for £22,995. It has flat repayments of £498.36 per month. Interest for the term of the loan was £6,906.90, so the total borrowed was £29,901.60

In month one, £226.44 went towards the interest and £271.92 went towards the capital.

In month 40 £75.48 went off the interest and £422.88 went off the capital.

People think that each instalment has an equal effect on reducing the capital owed - but it doesn't. So the settlement figure in early months appears unnattractive.

We both agree, but get to the same answer using different routes.

The settlement figure after two months instalments is £22,427. So I've paid £1,000 off £22,995 but I need to pay £22,427 to pay it off. This is the part that confuses people.

Regards - not wishing to start a row

Robert_Sterling_3

From a lenders point of view there are at least three different ways of looking at the amount of interest and the amount of repayment of Principal is  involved in each monthly payment.

e.g.

Method 1

The monthly payment is made up of the same amount of principal each month and the same amount of interest each month and they are in the same ratio to each other as is the oringinal loan to the total interest on the loan.
This is termed the straight line method.

Method 2

We know the amount of the loan and the interest rate.
We work out each month how much interest to charge on the outstanding balance subtract it from the monthly payment and subtract the difference from the outstanding balance.
This is termed the actuarial method.

Method Three

We work out each month how much interest will be rebated if the loan terminated on that day.
We will already have worked out the figure one month earlier.  The difference between the earlier figure and the new figure i.e.  The amount by which the rebate has decreased is the amount of interest earned that month.
This is called "The rule of 78 Method"

One of these methods suits the tax man.
One suits the shareholders
One serves another purpose.

I will spare you the maths but state that the interest in the early months of the loan using the Rule of 78 is such that it exceeds the monthly payment.

i.e.  The redemption figure, what you have to pay to terminate your loan, INCREASES month by month and exceeds the amount you borrowed by an increasing margin each month up to about the half way mark i.e.  5 years in the case of a 10 year loan.  It then decreases month by month in the next five years.

If the borrower keeps to the original contract it makes no difference to him/her what interpretation the lender puts on his figures.

Tr@cker

Does anyone know who actually produced the formula for rule 78 and why the banks use it ?
One things for sure, it's a big rip-off. I early settled a loan, paid up in exactly half the time but paid 2 thirds of the total interest as if i'd let the loan run it's full course.
They're on a good thing.