The Rule of 78s

            My father-in-law Sandy was a quiet, gentle man.  He’s passed away now, but his memory lives on in those of us who knew him well.  He left a lasting imprint on a large number of us, and he taught us many, many things. One of the minor things he taught me about was the rule of 78s.

Sandy was an engineer.  He sometimes did things that were perhaps unimaginable to those of us who had not been through the School of Engineering.  One of those feats was to perform the interest calculations on his new car loan.

If memory serves, Sandy bought a new Toyota.  He bought it on credit.  After he had received a few statements and made a few payments, Sandy actually got out his mathematical tools (a slide rule perhaps?) and he calculated the amount of interest that was being credited to his account with each payment that he had made.  Sandy wasn’t afraid of numbers.  I sometimes caught him reading books that had strange mathematical symbols.  So in truth, he probably did these calculations as much for fun as he did to check up on the vehicle lender.

Anyway, Sandy’s calculation showed that the lender wasn’t crediting his payments properly.  In other words, Sandy’s principal balance was not going down as quickly as it should have been.  The lender was applying too much of the payment towards interest and not enough of each payment to principal.

I remember Sandy coming down the hall shaking his head.  He told me what the problem was.  He said that he had discovered this problem with the lender’s calculations, and so he contacted them to let them know they were incorrectly crediting his payments, and that his principal balance should actually be lower than what was shown on his statements.  That was when he learned about the “Rule of 78s.”  The lender’s representative told Sandy that the interest was being correctly calculated, but that it was being calculated according to the “Rule of 78s” which meant, in essence, that the interest on the front end of the loan was being paid off at a higher rate than it would be at the end of the loan.  Apparently, when the Rule of 78s is applied, everything works out well in the end if the loan is paid over its full term on the basis stated in the loan papers and if the loan isn’t paid off early.  But if the loan is paid off early, then the lender collects a bit more interest than it would otherwise.

Sandy wasn’t happy about it.  But he had signed a contract that allowed the lender to credit his payments according to the Rule of 78s, and so Sandy figured out he would just pay off the car according to the loan terms (again, if memory serves, he subsequently decided to pay it off early).

I subsequently bought a car on credit, and sure enough, there on the loan application was a box that could be checked so that the “Rule of 78s” could be applied.  However, the box wasn’t checked, and so it wasn’t used in connection with my car loan.

Exactly what is the Rule of 78s? I couldn’t find an article in Encyclopedia Brittanica that discussed it.  But there is an article in Wikipedia.  The URL is   Reading this article?  It helps if you like math.  If you really, really like math, then you might enjoy the Wikipedia article on Rule of 72 Interest Calculations at   I was interested to find that some years ago a federal law was passed that prohibited use of the Rule of 78s on consumer transactions with a term of more than 61 months.  This law is found at 15 U.S.C. 1615 (here’s the link:   Most car loans are 60 months (or less) and so this federal law may not prohibit the use of the Rule of 78s on car loans.

How does this apply to the purchase of housing?  Most home loans are made for a term of more than 5 years (or 60 months).  Since 15 USC 1565 prohibits the application of the Rule of 78s to loans with a term of more than 61 months, most home loans would never be properly subject to the Rule of 78s.

Proper calculation and application of interest can be complex.  Persons with any question about their loan, whether about the interest or otherwise, should contact a trained professional.

Copyright 2023 ROBERT B. JACOBS