Precomputed loans, also known as precomputed interest loans, are the non-popular means of calculating interest rates on a car loan, which benefits the lender. Instead of sharing interests uniformly across the life of a loan, the interest is up-fronted. This means that more interest is paid at the start of the loan and reduced at the end of the loan life.
A borrower who makes minimum payments on a loan has no difference between a simple interest and a pre-computed interest auto loan. Your money will be gotten back if you repay your loan on time. However, it will be less than the simple interest 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 end of the loan instead of at the end of the loan repayment. Being aware of how precomputed loans work helps you regulate whether the loan is good for you or not.
How do Precomputed Loan Work?
Precomputed means the interest you are to pay over a loan life is calculated by the lender. 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 Loan 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 change the division of your interest without a loan. This is done through the rule of 78. The rule of 78 changes how your interest is being calculated and 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 of the overall interest in the first month, 11 and 78 in the second month, 10 and 78 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 for the car loan. If the interest is not foreloaded, 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 for 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 2 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 gotten 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 precomputed loan may be a disadvantage to you. Precomputed loans benefit the lender; it is 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, the 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 it is for you.
