Chapter 12 Business and Consumer Loans Section 3 Early Payoffs of Loans

Objectives Use the United States Rule for an early payment. Find the amount due on the maturity date using the United States Rule. Use the Rule of 78 when prepaying a loan.

Use the United States Rule for an Early Payment Common for a payment to be made on a loan before it is due Example: Refinance a debt to a lower rate Rule used by U.S. government and most states and financial institutions Payment first applied to any interest owed Balance is used to reduce principal

Using the United States Rule Step 1 Find the simple interest due from the date the loan was made until the date the partial payment is made. Use the formula I = PRT. Step 2 Subtract this interest from the amount of the payment. Step 3 Any difference is used to reduce the principal.

Using the United States Rule Step 4 Treat additional partial payments in the same way, always finding interest on only the unpaid balance after the last partial payment. Step 5 The remaining principal plus interest on this unpaid principal is then due on the due date of the loan.

Find the Amount Due on the Maturity Date Using the United States Rule If the partial payment is not large enough to pay the interest due, the payment is simply held until enough money is available to pay the interest due This type of partial payment offers no advantage to the borrower

Example Page 484 Quick Check 2

Use the Rule of 78 when Prepaying a Loan Rule of 78 allows a lender to earn more of the finance charge during the early months of the loan compared with the United States Rule Lenders typically use this rule to protect against early payoffs on small loans Effectively, the lender will earn a higher rate of interest in the event of an early payoff

Rule of 78 Based on a loan of 12 months Sum of the months 1 + 2 +3 +…+ 12 = 78 Finance charge: first month is 12/78 of the total charge 11/78 in the second month 10/78 in the third month and so on … 1/78 in the final month

Unearned Interest Total finance charge on an installment loan is calculated when a loan is first made Early payoff of a loan results in a lower finance charge Portion of the finance charge that has not yet been earned by the lender under the Rule of 78 is called unearned interest or refund

Finding Unearned Interest where U = unearned interest N = number of payments remaining F = finance charge P = original number of payments

Example Page 487 Problem 8