Precomputed Loan – What is it and How it Works

Precomputed loans, or precomputed interest loans, are a non-popular means of calculating car loan interest rates that benefit the lender. Instead of sharing interests uniformly across the life of a loan, the interest is up-front. This means that more interest is paid at the start of the loan and reduced at the end of its life.

Precomputed Loan - What is it and How it Works

A borrower who makes minimum payments on a loan has no difference between a simple interest loan and a pre-computed interest auto loan. Your money will be repaid if you repay your loan on time. However, it will be less than the simple interest on car loans. Precomputed loans are not common, but you need to be aware of them and how they work.

Using these loans, interest rates are calculated before the loan’s end instead of the loan repayment. Being aware of how precomputed loans work helps you determine whether the loan is good for you or not.

How do Precomputed Loans Work?

When interest is precomputed, the lender determines the total interest amount you’ll owe over the loan’s lifetime and includes it in your loan agreement. This type of loan adds the calculated interest to the principal interest and divides it into a monthly repayment term. Precomputed loans are similar to other car loans that use simple interest.

This method benefits the lender if the borrower repays the loan on time. Unlike simple interest, this loan is not commonly used by lenders. However, this loan method is mainly used by lenders who work with borrowers with bad credit. This is because they pay higher interest rates than those with good credit.

Precomputed Loans vs. Simple Interest Loans

Precomputed loans front-load the interest you pay, while simple interest divides the interest you pay accordingly. If you pay more than the minimum payment, the principal will be cut down. This means that you will be making fewer interest payments the following month. In cases where you only make the minimum payment, no difference will be made between precomputed interest loans and simple interest. If you need a plan that allows you to repay your car loan on time, simple interest loans are a better option to go for.

Rule of 78

Legally, lenders are not allowed to charge interest that has not been accrued. However, lenders can modify the interest rate on your loan without requiring a new loan agreement. This is done through the rule of 78. The rule of 78 changes how your interest is calculated, not the actual amount you have to pay for the loan. The rule of 78 is an important strategy and the basis for precomputed loans.

Lenders sum up all the months in the loan years, which is a total of 78, and place interest in reverse order. In one year, you may pay between 12 and 78 percent of the overall interest in the first month, 11 and 78 percent in the second month, 10 and 78 percent in the third month, and so on. This, however, means that you make more interest payments at the beginning of your loan repayment.

How is an Interest Refund Calculated for Precomputed Loans?

Interest refunds are calculated by misusing the interest already paid from the interest left on the car loan. If the interest is not fore-loaded, you may have to pay a larger amount for interest at the start of your loan. If it takes a longer time to repay your loan, you may get fewer refunds. The example below is how lenders calculate how much interest they can keep on a loan.

A $30,000 loan has a 60-month loan term and a 6 percent interest rate. You will have to make an interest payment of $4,800. What if you repay the loan two years before time? Lenders calculate how much interest they can keep to themselves using the below steps.

  • Multiply 78 by the number of years it took to repay the loan.
  • Divide the number gotten by the value gotten after multiplying the Rule of 78 by the actual loan term.

In the end, multiply the value by 100 to get the interest percentage rate. In the end, the lender will remove their percentage and refund the rest to you.

Benefits of Precomputed Loans

If you do not repay your loan on time, a pre-computed loan may be a disadvantage to you. Precomputed loans benefit the lender; they are most likely rendered to borrowers with bad credit. In cases where you do not qualify for a simple interest loan, this loan is a benefit for you. However, there are not many differences in the amount of interest you pay for a precomputed car loan.

Why Should You Avoid Precomputed Loans?

Simple interest is one of the best options for every borrower. Even when you do not plan to repay your loan on time, simple interest can help change the situation. When the situation changes, a simple interest loan allows you to pay less interest. Because you pay more interest at the beginning of a precomputed loan, you may not be able to save if the loan is repaid on time. Your savings may be little, but it is still your money. The less you have to pay for a loan, the better for you.