Rule of 78s

The Rule of 78s, also known as the sum-of-the-digits method, is a formula used to allocate precomputed interest across the life of a loan. It front-loads interest payments, meaning that in the early months, a larger portion of each installment goes toward interest, while later payments contribute more toward principal.

The name comes from the sum of the numbers 1 through 12 (which equals 78) for a one-year loan, though the method can be applied to loans of different lengths. In auto financing, the Rule of 78s has historically been used to favor lenders, as borrowers who pay off loans early do not receive proportional savings in interest.

Instead, they end up paying much of the interest upfront, reducing the benefit of prepayment. Because of its borrower-unfriendly nature, the Rule of 78s has been restricted or outlawed for certain loan types in many states, though it may still appear in some contracts.

Borrowers should be cautious when reviewing loan agreements and ask specifically how interest is calculated. Understanding the Rule of 78s empowers consumers to avoid hidden costs and advocate for simple interest loans, which are fairer and more transparent.

For lenders, it provides a predictable revenue stream but at the expense of borrower goodwill. Informed borrowers can better evaluate loan structures and protect themselves against paying excessive interest.