Rule Of 78

AAA

DEFINITION of 'Rule Of 78'

A method of allocating the interest charge on a loan across its payment periods. Under the Rule of 78, periods are weighted by comparing their numerical values to the sum of all the digits of the periods. The weights are applied in reverse, applying large weights to early periods.


INVESTOPEDIA EXPLAINS 'Rule Of 78'

When paying off a loan, the repayments consist of two parts: the principal and the interest charge. The Rule of 78 weights earlier payments with more interest than later ones. If the loan is not terminated or prepaid early, the total interest paid between simple interest and the Rule of 78 will be equal. However, because the Rule of 78 weights the earlier payments with more interest than a simple interest method, paying off a loan early will result in the borrower paying more interest overall.

This method of allocating interest was commonplace in loans for consumer goods, such as automobiles. However, the U.S. government has outlawed the use of the Rule of 78 for loans longer than five years. This is largely because this method penalizes borrowers who pay off debts early.

RELATED TERMS
  1. Mortgage

    A debt instrument, secured by the collateral of specified real ...
  2. Maturity

    The period of time for which a financial instrument remains outstanding. ...
  3. Loan

    The act of giving money, property or other material goods to ...
  4. Prepayment Risk

    The risk associated with the early unscheduled return of principal ...
  5. Interest

    1. The charge for the privilege of borrowing money, typically ...
  6. Compounding

    The ability of an asset to generate earnings, which are then ...
RELATED FAQS
  1. What is the difference between "closed end credit" and a "line of credit?"

    Depending on the need, an individual or business may take out a form of credit that is either open- or closed-ended. While ... Read Full Answer >>
  2. In what instances does a business use closed end credit?

    The most common types of closed-end credit used by both businesses and individuals are mortgages and auto loans. Businesses ... Read Full Answer >>
  3. What are the typical requirements to qualify for closed end credit?

    Typical requirements for a consumer to qualify for closed-end credit include satisfactory income level and credit history, ... Read Full Answer >>
  4. What are the long-term effects of delinquent accounts?

    Delinquency occurs when borrowers fail to make payments on their loans. All loan borrowers should do their best to avoid ... Read Full Answer >>
  5. How was the American Dream impacted by the housing market collapse in 2008?

    The American Dream was seriously damaged by the housing market collapse in 2008. In many ways, the American Dream is a self-fulfilling ... Read Full Answer >>
  6. How much risk is associated with subprime mortgages?

    A large amount of risk is associated with subprime mortgages. Since the mortgages are specifically for people who do not ... Read Full Answer >>
Related Articles
  1. Investing Basics

    Understanding The Time Value Of Money

    Find out why time really is money by learning to calculate present and future value.
  2. Home & Auto

    New Wheels: Lease Or Buy?

    These two major ways to obtain a car have very different advantages and drawbacks. Find out which is best for you.
  3. Retirement

    Getting A Loan Without Your Parents

    Use the 5 "W"s to finance your dreams without banking on a second signature.
  4. Options & Futures

    Payday Loans Don't Pay

    Hold too tightly to this rescue line and you'll soon be drowning in debt.
  5. Credit & Loans

    Explaining Credit Ratings

    A credit rating is a third-party assessment about the creditworthiness of an individual or entity.
  6. Economics

    What is a Subprime Mortgage?

    Subprime mortgages are offered to borrowers with low credit ratings, usually 600 or below.
  7. Credit & Loans

    Study Abroad: Budget For Brazil

    Interested in study, food and adventure in one of the fastest growing economies in the world? Check out what Brazil costs.
  8. Home & Auto

    Strategies To Buy The Perfect Vacation Home

    Ask yourself these six questions to make the right decision about a vacation property.
  9. Economics

    Explaining Tenor

    Tenor is the length of time to maturity of a debt, contract or loan.
  10. Economics

    How Does a Lien Work?

    A lien gives a creditor the legal right to seize and sell property, then use the proceeds to pay off a borrower’s debt.

You May Also Like

Hot Definitions
  1. National Currency

    The currency or legal tender issued by a nation's central bank or monetary authority. The national currency of a nation is ...
  2. Treasury Yield

    The return on investment, expressed as a percentage, on the debt obligations of the U.S. government. Treasuries are considered ...
  3. Bund

    A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury ...
  4. European Central Bank - ECB

    The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed ...
  5. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
  6. Current Account Deficit

    A measurement of a country’s trade in which the value of goods and services it imports exceeds the value of goods and services ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!