The Rule of 78: How Precomputed Interest Makes Early Payoff Expensive
How the Rule of 78s allocates interest, a step-by-step example against the actuarial method, the federal limit for loans over 61 months and how to spot it in a loan contract.
Listen to this article
Key takeaways
- The Rule of 78 (also "Rule of 78s" or sum-of-the-digits method) assigns more interest to the early months of a precomputed loan.
- It only matters if you pay off early: your refund of unearned interest is smaller than under the actuarial method.
- Federal law prohibits it for precomputed consumer loans with terms longer than 61 months; many states restrict it further.
- Look for the words "precomputed" and "Rule of 78" in the contract, or ask whether the loan uses simple interest.
Most modern loans charge simple interest on the balance you actually owe, so every early or extra payment saves interest immediately. A precomputed loan works differently: the total finance charge is calculated up front and added to the debt. If you pay it off early, the lender refunds the interest it has not yet "earned". The Rule of 78 is a method of deciding how much that is, and it favors the lender.
Please note
General information about U.S. federal law as of October 2026. State rules on precomputed loans and refund methods vary; your contract and state law decide what applies to you.
Where the name comes from
For a 12-month loan, number the months backwards from 12 to 1 and add them up: 12 + 11 + 10 + … + 1 = 78. Under the rule, the lender treats 12/78 of the total finance charge as earned in the first month, 11/78 in the second, and so on until 1/78 in the last month. For longer loans the same logic applies with a larger sum: a 36-month loan uses 666, a 60-month loan uses 1,830.
Interest earned in month k = Total finance charge × (n − k + 1) ÷ (n × (n + 1) ÷ 2)
In the first month of a 12-month loan, that is 12/78, or 15.4% of all the interest, although you have only made one of twelve payments.
Rule of 78 vs. actuarial method: an example
The actuarial method, which mirrors simple interest, assigns interest in each period based on the balance still owed. The Rule of 78 front-loads it a little more than that. The table compares the payoff amounts for an $8,000 precomputed loan at 22% APR over 36 months (payment $305.52, total finance charge $2,998.72).
| Paid off after | Payoff, actuarial | Payoff, Rule of 78 | Extra cost |
|---|---|---|---|
| 6 payments | $7,002.11 | $7,071.90 | $69.79 |
| 12 payments | $5,889.30 | $5,981.71 | $92.41 |
The penalty grows with the size and rate of the loan and with how early you pay off. For a hypothetical $15,000 loan at 15% over 60 months, paying off after 24 months would cost $219.33 more under the Rule of 78 than under the actuarial method. That is exactly why federal law limits the method to shorter loans.
What federal law says
Under 15 U.S.C. § 1615, for precomputed consumer credit transactions with a term of more than 61 months consummated after September 30, 1993, the creditor must calculate any refund of interest on prepayment using a method at least as favorable to the consumer as the actuarial method. In practice, that rules out the Rule of 78 for those longer loans. The same law requires creditors to promptly refund unearned interest when a consumer prepays in full. For loans of 61 months or less, federal law does not ban the method, but many states do or limit it.
Where you still might find it
- Some subprime and buy-here-pay-here auto loans.
- Certain small installment loans from consumer finance companies.
- Some retail installment contracts for furniture, electronics or appliances.
Mainstream banks, credit unions and online personal loan lenders typically use simple interest, which you can confirm in the loan documents.
How to check your contract
- Look in the Truth in Lending disclosure and the contract for "precomputed", "Rule of 78", "sum of the digits" or "refund of unearned finance charge".
- Check whether the contract says interest accrues on the unpaid principal balance, which indicates simple interest.
- Ask the lender for a payoff quote at several future dates to see how much early payoff saves.
- If you plan to pay early, choose a simple-interest loan with no prepayment penalty.
Is a Rule of 78 loan always bad?
If you keep the loan to the end, the method makes no difference: you pay the same finance charge either way. The cost appears only with early payoff or refinancing. Since many borrowers do refinance or sell the car before the term ends, it is still worth avoiding when you have the choice.
Frequently asked questions
Is the Rule of 78 legal?
Federally, it cannot be used for precomputed consumer loans with terms over 61 months. For shorter loans it is not banned by federal law, but many states prohibit or restrict it.
How do I know if my car loan uses the Rule of 78?
Read the contract for the terms "precomputed" or "Rule of 78" and ask the lender how early payoffs are calculated. Simple-interest loans state that interest accrues daily or monthly on the unpaid balance.
Does the Rule of 78 change my monthly payment?
No. The payment and total finance charge are fixed. Only the refund you receive when you pay off early is affected.
Can I refinance a Rule of 78 loan?
Yes. Ask for the exact payoff amount first, then compare it with the savings from the new loan to see whether refinancing still pays.
What is the actuarial method?
It assigns interest to each period based on the outstanding balance at the agreed rate, which is how simple-interest loans work. It is the standard federal law requires for precomputed loans over 61 months.
