question archive The "Rule of 78" is a rule of thumb approximating the interest refund owed to a borrower repaying a term loan
The "Rule of 78" is a rule of thumb approximating the interest refund owed to a borrower repaying a term loan
Subject:FinancePrice: Bought3
The "Rule of 78" is a rule of thumb approximating the interest refund
owed to a borrower repaying a term loan. The rule is an example of the sum-of-digits allocation method. To apply the rule, it is necessary first to calculate the refund ratio. This ratio is computed as follows. Sum the integers 1 through n, where n represents the total number of installments on the original loan. This sum is the denominator of the refund ratio. Next, add the integers 1 through m, where m represents the number of installments cancelled by the prepayment. The sum is the numerator of the refund ratio. Finally, multiply the refund ratio by the total finance charge to compute the refund paid to the borrower. Here, the total finance charge is the sum of all contractual interest payments over the life of the loan.
A $1,000,000 note is to be repaid in 360 equal monthly installments at an interest rate of 1% per month. The borrower prepays after 10 years. Calculate the fixed monthly payment, the original finance charge, the true refund, the "Rule of 78" refund, and the loss to the borrower due to the use of the "Rule of 78."
