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. Compounding

    The ability of an asset to generate earnings, which are then ...
  3. Interest

    1. The charge for the privilege of borrowing money, typically ...
  4. Loan

    The act of giving money, property or other material goods to ...
  5. Maturity

    The period of time for which a financial instrument remains outstanding. ...
  6. Prepayment Risk

    The risk associated with the early unscheduled return of principal ...
Related Articles
  1. Understanding The Time Value Of Money
    Investing Basics

    Understanding The Time Value Of Money

  2. New Wheels: Lease Or Buy?
    Home & Auto

    New Wheels: Lease Or Buy?

  3. Getting A Loan Without Your Parents
    Retirement

    Getting A Loan Without Your Parents

  4. Payday Loans Don't Pay
    Options & Futures

    Payday Loans Don't Pay

comments powered by Disqus
Hot Definitions
  1. Walras' Law

    An economics law that suggests that the existence of excess supply in one market must be matched by excess demand in another ...
  2. Market Segmentation

    A marketing term referring to the aggregating of prospective buyers into groups (segments) that have common needs and will ...
  3. Effective Annual Interest Rate

    An investment's annual rate of interest when compounding occurs more often than once a year. Calculated as the following: ...
  4. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option ...
  5. Odious Debt

    Money borrowed by one country from another country and then misappropriated by national rulers. A nation's debt becomes odious ...
  6. Takeover

    A corporate action where an acquiring company makes a bid for an acquiree. If the target company is publicly traded, the ...
Trading Center