How do I know if my loan uses the Rule of 78?

Look for the phrases 'precomputed interest,' 'sum-of-digits,' or 'Rule of 78' in your loan contract. Also check the prepayment or early payoff section. If paying off early results in you owing more interest than the remaining scheduled payments suggest, the loan likely uses front-loaded interest. Ask your lender directly: 'How is interest calculated if I pay off early?'

How much more does the Rule of 78 cost?

On a 12-month loan, a borrower who pays off after 6 months (halfway) has already paid about 74% of the total interest under the Rule of 78, versus 50% under simple interest. The difference grows with higher APRs and shorter payoff times. On a $10,000 loan at 24% APR paid off at month 6, the Rule of 78 costs roughly $140–$200 more in interest than simple interest.

How can I avoid the Rule of 78?

Before accepting a loan, ask whether interest is calculated as 'simple interest' (accrued on the remaining principal daily) or 'precomputed' (Rule of 78). Most major banks and credit unions use simple interest. Online lenders like SoFi, LightStream, and LendingClub use simple interest. Avoid loans from buy-here-pay-here car dealers, some finance companies, and high-rate personal loan lenders without confirming the interest method.

Rule of 78 2026 — How Precomputed Interest Costs You More

Q: What is the Rule of 78?

The Rule of 78 (also called the sum-of-digits method) is a precomputed interest calculation that front-loads most of the interest into the early months of a loan. If you pay off the loan early, you will have paid a disproportionately large share of the total interest, saving less than you would with a simple interest loan. The name comes from the sum of the digits 1 through 12, which equals 78 — used to calculate the monthly interest weight in a 12-month loan.

Q: Is the Rule of 78 legal?

The Rule of 78 is illegal on loans longer than 61 months in the United States, per the Truth in Lending Act (TILA). For shorter-term loans, it is still legal in many states. Some states ban it entirely for consumer loans. High-interest personal loans, car dealer financing, and some payday-alternative loans may still use it. Always read the prepayment penalty disclosure in your loan agreement.

Paying off a loan early should save you money — but with the Rule of 78, it might save far less than you expect. The Rule of 78 is a front-loaded interest calculation that ensures you pay the lion’s share of interest in the first half of the loan. If you pay off early, you’ll have already handed over most of the interest without getting the benefit of reducing future payments proportionally.

What Is the Rule of 78?

The Rule of 78 — also called the sum-of-digits method — is a way of calculating how much of your total interest is allocated to each monthly payment. Instead of accruing interest daily on the remaining balance (simple interest), the Rule of 78 assigns a fixed portion of the total interest to each month, weighted heavily toward the beginning.

Where the name comes from: Add up the digits 1 through 12 (the months in a one-year loan): 1 + 2 + 3 + … + 12 = 78. This sum is the denominator in the interest allocation formula.

How the Rule of 78 Allocates Interest

For a 12-month loan, each month’s interest share is:

Month	Fraction of Interest	Cumulative Share
1	12/78 = 15.4%	15.4%
2	11/78 = 14.1%	29.5%
3	10/78 = 12.8%	42.3%
4	9/78 = 11.5%	53.8%
5	8/78 = 10.3%	64.1%
6	7/78 = 9.0%	73.1%
7–12	6+5+4+3+2+1/78	remaining 26.9%

By month 6, you’ve paid 73% of all interest but only made 50% of payments. Compare this to a simple interest loan where you’d have paid roughly 50% of interest at the halfway point.

Rule of 78 vs. Simple Interest — Worked Example

Say you borrow $10,000 at 24% APR for 12 months. Your monthly payment is $945. Total interest is approximately $1,345.

If you pay off at month 6:

Method	Interest Already Paid	Remaining Interest Saved	You Pay at Payoff
Simple Interest	~$672	~$673	~$5,000 + $673 remaining = ~$5,000
Rule of 78	~$983	~$362	~$5,000 + $362 remaining

The Rule of 78 costs you roughly $311 more in this scenario. The gap grows larger with higher interest rates and longer original loan terms.

Is the Rule of 78 Legal?

Yes, in many circumstances — but with limits:

Loans longer than 61 months: The Rule of 78 is banned under the Truth in Lending Act (15 U.S.C. § 1615) for loans exceeding 61 months.
Loans 61 months or shorter: Still legal federally, though several states ban it for consumer loans entirely.
State bans: States including North Carolina, Massachusetts, and New Mexico prohibit the Rule of 78 on consumer loans. Check your state’s consumer lending laws.

Where You’re Most Likely to Encounter the Rule of 78

Buy-here-pay-here auto dealers
High-rate personal loan companies
Older finance company loans
Some payday alternative loans (PALs) from smaller institutions
Short-term installment loans from non-bank lenders

You’re unlikely to find it at: Major banks, credit unions, or reputable online lenders like SoFi, LightStream, Upgrade, or LendingClub — these all use simple interest.

How to Calculate Your Rule of 78 Payoff Amount

For a loan with N total months and M months remaining at payoff:

$$\text{Unearned interest} = \text{Total interest} \times \frac{M \times (M + 1)}{N \times (N + 1)}$$

Example: 12-month loan, $1,345 total interest, paying off after month 6 (6 months remaining):

$$\text{Unearned interest} = $1,345 \times \frac{6 \times 7}{12 \times 13} = $1,345 \times \frac{42}{156} = $362$$

So you’d save $362 in interest — but would have paid $983 of $1,345 total interest in just 6 months.

How to Avoid the Rule of 78

Ask the right question: “Is this a simple interest or precomputed interest loan?”
Read the contract: Look for “precomputed,” “sum-of-digits,” or prepayment penalty language
Check TILA disclosures: Your Truth in Lending disclosure must state the prepayment penalty conditions
Choose established lenders: Banks, credit unions, and major online lenders almost universally use simple interest
Refinance if stuck: If you’re in a Rule of 78 loan and it makes financial sense, refinancing with a simple interest lender may save money even after accounting for origination fees

What to Do If You Have a Rule of 78 Loan

Run the payoff math before paying off early — your lender must provide a payoff quote
Compare the payoff quote to what you’d expect from simple interest on the remaining balance
Factor this into any early payoff decision — the savings may be smaller than you think
Check your state’s rights — if your loan violates state anti-precomputed-interest laws, you may have a legal claim

Written by WealthVieu

WealthVieu researches and writes data-driven personal finance guides using primary sources including the IRS, Bureau of Labor Statistics, Federal Reserve, and Census Bureau.

The content on Wealthvieu is for informational purposes only and should not be considered financial, tax, or investment advice. Consult a qualified professional before making financial decisions. Full disclaimer · Editorial policy