What is Rule of 78?

Full Definition

The Rule of 78 (also called the sum-of-digits method) is a way of allocating the total interest due on a fixed-term loan across its individual monthly repayments so that a disproportionately larger share of interest is charged in the earlier months of the loan and progressively less in later months, rather than spreading interest evenly or in line with the reducing balance actually still owed. The name comes from the sum of the digits 1 to 12 (1+2+3...+12 = 78) used in the calculation for a 12-month loan, with the same principle scaling up for longer terms; the practical effect is that a borrower who repays a Rule of 78 loan early receives a smaller interest rebate than they would under a standard reducing-balance calculation, because more of the total interest has already been allocated to, and effectively already earned by the lender in, the early months of the agreement. Consumer credit rules introduced in the UK largely phased out the Rule of 78 for new regulated consumer credit agreements, requiring lenders instead to calculate any early settlement rebate using a method based on the actual daily reducing balance, which is fairer to borrowers who repay early, though older agreements taken out before the rule change may still reference the Rule of 78 method. Understanding the Rule of 78, even though it is now rarely used for new lending, remains useful background for anyone dealing with an older hire purchase, personal loan or car finance agreement taken out some years ago, since it explains why an early settlement figure on such an agreement may be higher than a simple pro-rata calculation of remaining interest would suggest.

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