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What exactly is a calculated interest auto loan? Advertiser Disclosure Advertiser Disclosure We are an independent, advertising-supported comparison service. Our aim is to assist you make better financial decisions by providing you with interactive tools and financial calculators, publishing original and objective content. This allows users to conduct research and compare data for free – so that you can make informed financial decisions. Bankrate has agreements with issuers, including but not limited to, American Express, Bank of America, Capital One, Chase, Citi and Discover. How We Earn Money The deals that are advertised on this website are provided by companies that compensate us. This compensation could affect how and when products appear on this website, for example, for example, the order in which they may appear within the listing categories in the event that they are not permitted by law. Our mortgage, home equity and other home loan products. But this compensation does not influence the information we provide, or the reviews that appear on this website. We do not include the entire universe of businesses or financial offerings that could be open to you.
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3 min read Published 17 October 2022
Writer: Kellye Guinan Written by Personal and Business Finance Contributor
Kellye Guinan is a freelance editor and writer who has more than 5 years experience working in the field of personal finance. She’s also a full-time librarian at the local library where she helps her community gain access to information on financial literacy, in addition to other topics.
Editor: Rhys Subitch Edited by Auto loans editor
Rhys has been writing and editing for Bankrate since late 2021. They are dedicated to helping readers gain the confidence to control their finances through providing clear, well-researched information that break down complex subjects into bite-sized pieces.
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Precomputed interest is an uncommon way of calculating the interest rate on an automobile loan that benefits the lender. Instead of spread the interest out over the course of the loan the interest is front loaded, meaning you pay higher than you would at the beginning of the loan and less towards the end. If you pay the minimum amount it is not a difference between the precomputed interest auto loans. You will get some money back if you pay off the auto loan in advance, but it will be smaller than that of a regular auto loan. The way a precomputed interest auto loan operates «Precomputed» means the lender calculates the interest you’ll pay over the loan duration. It then adds this amount to your principal and divides it into monthly installments, similar to traditional auto loans which use simple interest. The way interest is calculated is advantageous to lenders if you are able to pay early. They’re not as popular as regular interest loans. It is more likely that you will see them offered by buy-here, pay-here dealers as well as other lenders who work in conjunction with bad credit borrowers. Because of this, they tend to have very high interest rates. The rate you pay will be an interest rate as well as an annual percentage rate that includes any additional fees. Precomputed interest in comparison to. simple interest While precomputed interest is a way to front load what you pay, split the interest paid equally. If you pay higher than your minimum decreases the principal, which results in a lower interest rate the next month. If you make only the minimum payment then there will be no distinction between the two methods to calculate interest. However, if you are planning to pay off your auto loan quickly, interest-only loans are the better choice. It is a rule of law that says 78. Lenders are not legally allowed to charge you interest which isn’t earned. However, they are able to alter how interest is distributed throughout the duration of a loan. This rule changes the way you pay, but will not impact the total amount you have to pay. This is among the most popular strategies — and also the basis for precomputed interest auto loans. Lenders add up all the months of the year which add up to 78, the interest is then applied in reverse. For the course of a one-year loan, you would pay 12/78 of the total amount due in the first month. The second month will be 11/78, the 3rd month is 10/78, and the cycle continues. This means that you’ll have to pay more at the start the term of your loan. You can get a rebate on interest when you repay your loan early, though you will not save as much than you could with a standard interest loan. Some states have banned using the rule of 78- and it is nationally unlawful for loans that last 61 months or longer. Examine the laws of your state to make sure your lender isn’t providing you with an illegal loan. How is an interest refund calculated for precomputed auto loans? They are calculated using subtracting interest you’ve already paid from the balance of interest on the loan. But because the interest is frontloadedwhich means you pay a higher part at the start of the loan and you’ll have less refunded the longer you take to repay the loan. For example, you will be paying around $4,800 in interest for a $30,000 loan with a 60-month repayment term and a 6-percent interest rate. If you repay your loan two years early, the lender will add 3 years of interest -multiplying 78 by 3 to come up with 234 then divide the result by 390, that’s the principle of 78 spread over five years. The lender will have made 60 percent of its interest at this moment. So you will receive an amount of refunding the remaining 40%, which is $1,920. Benefits and drawbacks of precomputed interest Precomputed interest is only an advantage in the event that you need you to settle your loan in advance. Otherwise, it will cost you the same amount as a regular interest loan. Pros Because precomputed interest benefits the lender it is more likely to be offered to those who have less than perfect credit. If you don’t qualify for a simple interest auto loan but you might be able to get precomputed interest loan. There’s no distinction in how much interest you pay with a precomputed interest auto loan. If you stick to the minimum payment plan for precomputed interest, the loan is precisely identical to a regular interest loan.
Cons The biggest drawback to precomputed interest is early payments. You’ll pay more interest if you have to pay back your loan in advance that means less savings for being financially responsible. Since lenders can only use the rule of 78 on loans that have terms of 30 months or more, you might have higher monthly payments. If you’re only qualified for a precomputed-interest auto loan, your loan may be more expensive from month to month.
Why you should avoid precomputed interest car loans In general basic interest will be the best option for most borrowers. Even if you don’t have plans to repay your loan at a later date the situation may change. In the event that it does, a straightforward interest loan will mean you pay less in total. Because you pay more in interest at the start of an auto loan you’ll be missing savings if pay off your loan in a timely manner. It may only be only a tiny difference, but it’s still your money. The less you have to pay your lender and the lower your monthly payments, the better. The bottom line is that precomputed interest auto loans are not a good idea however they are not a bad thing when you plan to pay minimum monthly payments. Still, you should to look for more lenders and possibly a better rate.
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Written by Business and personal finance contributor
Kellye Guinan is a freelance editor and writer with over five years of experience in personal finance. She is also a full-time worker at her local library in which she assists the community access information about financial literacy, as well as other topics.
Editor: 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 to take control of their finances with precise, well-researched and well-understood information that is broken down into complicated subjects into digestible pieces.
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