# Understanding the Rule of 78: Lender Tactics & Interest Calculations

## What Is the Rule of 78?

The Rule of 78 is a loan [interest calculation method](https://www.investopedia.com/ask/answers/126.asp) that benefits lenders by front-loading interest payments, impacting borrowers who might pay off loans early. This practice, common with fixed-rate non-revolving loans, means borrowers pay more interest earlier, reducing potential savings. Understanding this rule is vital for borrowers considering early repayment.

### Key Takeaways

*   The Rule of 78 method allocates more interest payments to the earlier months of a loan, favoring lenders over borrowers.
*   For loans with the Rule of 78 provisions, borrowers pay more interest early in the loan cycle, reducing potential savings if paid off early.
*   This method is primarily used for short-term, fixed-rate loans, especially with subprime borrowers.
*   The Rule of 78 was made illegal in the U.S. for loans longer than 61 months, with some states implementing stricter rules.
*   Calculating interest using the Rule of 78 results in a borrower paying slightly more interest if the loan is paid off early compared to simple interest loans.

## How the Rule of 78 Impacts Borrowers and Lenders

The Rule of 78 gives greater weight to months in the earlier part of a borrower’s loan cycle when calculating interest, which increases the profit for the lender. This type of interest calculation schedule is primarily used on fixed-rate [non-revolving loans](https://www.investopedia.com/terms/r/revolving-account.asp). The Rule of 78 is an important consideration for borrowers who potentially intend to pay off their loans early.

> **Important**
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> With the Rule of 78, borrowers pay more interest earlier, often more than with a typical loan.

## Breaking Down Rule of 78 Loan Interest Calculations

Although the Rule of 78 method is more complex than APR, both result in the same total interest if paid over the full term.

The Rule of 78 methodology gives added weight to months in the earlier cycle of a loan. Short-term installment lenders often use it for [subprime borrowers](https://www.investopedia.com/terms/s/subprime-borrower.asp).

In the case of a 12-month loan, a lender would sum the number of digits through 12 months in the following calculation:

*   1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10 + 11 + 12 = 78

In a one-year loan, the total summing to 78 explains the Rule of 78; for two years, it totals 300.  

Once months are summed, lenders apply more interest to earlier months. In a one-year [loan](https://www.investopedia.com/terms/l/loan.asp), the first month gets 12/78 of the interest, dropping each month. For two years, it starts at 24/300.

## Comparing Rule of 78 and Simple Interest Loans

When paying off a loan, the repayments are composed of two parts: the principal and the interest charged. The Rule of 78 weights the earlier payments with more interest than the later payments. If the loan is not terminated or prepaid early, the total interest paid between simple interest and the Rule of 78 will be equal.

Paying off a Rule of 78 loan early means paying more interest compared to simple interest.

In 1992, the legislation made this type of financing illegal for loans in the United States with a duration of greater than 61 months. Certain states have adopted more stringent restrictions for loans less than 61 months in duration, while some states have outlawed the practice completely for any loan duration. Check with your state's Attorney General's office prior to entering into a loan agreement with a Rule of 78 provision if you are unsure.

The difference in savings from early prepayment on a Rule of 78 loan versus [a simple interest loan](https://www.investopedia.com/terms/s/simple_interest_mortgage.asp) is not significantly substantial in the case of shorter-term loans. For example, a borrower with a two-year $10,000 loan at a 5% fixed rate would pay total interest of $529.13 over the entire loan cycle for both a Rule of 78 and a simple interest loan.

In the first month of the Rule of 78 loan, the borrower would pay $42.33. In the first month of a simple interest loan, the interest is calculated as a percent of the outstanding [principal](https://www.investopedia.com/terms/p/principal.asp), and the borrower would pay $41.67. A [borrower](https://www.investopedia.com/terms/c/co_borrowers.asp) who would like to pay the loan off after 12 months would be required to pay $5,124.71 for the simple interest loan and $5,126.98 for the Rule of 78 loan.

## The Bottom Line

The Rule of 78 is an interest calculation method that favors lenders by front-loading interest payments, making it costly for borrowers who wish to pay off loans early. While lenders benefit from receiving more interest in the early months, borrowers should be wary, particularly if prepayment is anticipated. The method is less significant for short-term loans, given the minimal savings difference compared to simple interest loans. Due to its financial implications, the Rule of 78 is illegal for loans over 61 months in the U.S., with some states applying stricter regulations.

Before agreeing to loans utilizing this method, borrowers should consult financial professionals and check with state laws to make informed decisions.