The two interest structures, in a sentence
Simple interest: the lender calculates interest each day based on your remaining balance. As you pay down principal, interest charges shrink.
Precomputed interest: the lender calculates total interest up front for the full term, adds it to the principal, and amortizes the combined number across your payments. Paying off early doesn't reduce what you owe.
For an identical APR and term, both structures give the same monthly payment if you pay exactly on schedule. They diverge the moment you pay early or pay extra principal.
Why simple interest is friendlier
Take a $20,000 loan, 7% APR, 60 months. Both structures: monthly payment $396.
Now imagine you decide at month 36 to pay off the remaining balance.
- Simple interest: lender shows you the actual remaining principal — about $9,150. You write that check, the loan closes, you stop paying interest.
- Precomputed interest (Rule of 78s): the lender pre-allocated total interest of $3,761 across all 60 months. You owe a "payoff amount" calculated using the Rule of 78s — typically a few hundred dollars more than the simple-interest balance because more of the early-month interest was front-loaded.
The gap on a 60-month loan is small but real — $200–$500 in extra interest you pay on a precomputed loan when you pay off early. On longer terms, the gap widens.
What is the "Rule of 78s"?
An old method (the name comes from 1+2+3+...+12=78, the sum of digits in a 12-month year) for allocating precomputed interest. It deliberately front-loads interest into the first months of the loan, so that if you pay off early, you've already "used up" most of the precomputed interest.
The Rule of 78s is illegal on consumer loans longer than 61 months in many states, but still legal on shorter loans in some jurisdictions. It's mostly a relic at this point — but it does still appear on some Buy Here Pay Here loans and a few subprime products.
Where you'll see precomputed loans
The vast majority of auto loans in the U.S. are simple interest. You're most likely to encounter precomputed in three places:
- Buy Here Pay Here dealerships, especially deep subprime ones
- Some subprime lenders, particularly those targeting borrowers with credit below 550
- A few state-specific products, where state law allows precomputed interest on shorter-term loans
If you're financing through a credit union, a major bank, or any of the well-known online lenders (LightStream, AutoPay, Caribou, Capital One, etc.), it's simple interest. Confirm anyway, but it'll be simple.
How to tell which kind of loan you're being offered
Three places to look in your loan documents:
1. The contract heading
Federal law requires the interest type to be disclosed. Look for "simple interest contract" or "precomputed contract" in the document title or the first paragraph.
2. The "prepayment penalty" or "rebate" section
Simple-interest loans don't need a "prepayment rebate" because there's no precomputed interest to refund. Precomputed loans typically include language about "rebate calculation" or "Rule of 78s" or "actuarial method." If you see those terms, it's precomputed.
3. The TILA disclosure
The "Total Finance Charge" line shows the dollar amount of interest. On a precomputed loan, this number is locked. On a simple-interest loan, it's the maximum if you pay exactly on schedule — you'll pay less if you prepay.
What to do if you signed a precomputed loan
Three options:
- Refinance into a simple-interest loan from a credit union or online lender. This is the cleanest fix and frequently improves your APR too.
- Pay on schedule, not early. Counterintuitively, the precomputed structure means there's no benefit to extra principal payments. Make minimums and put the extra cash elsewhere — high-interest debt, savings, or invested.
- If you can pay off in full early, request the payoff amount in writing. Compare it to what a simple-interest loan would require. If the gap is $100–$300, just pay it. If the gap is $1,000+, refinance instead.
The "interest in advance" myth
Some borrowers believe simple-interest loans charge "interest in advance" because the first payment seems heavy on interest. They don't. The interest in your first payment is the interest accrued in that first month on the full principal. Once principal starts dropping, monthly interest drops too. There's nothing being charged "in advance."
The confusion happens because the front-loaded look of an amortization schedule resembles precomputed interest superficially. But the mechanism is different: simple interest is just math against the current balance.
Why simple interest matters even if you don't plan to pay early
Three reasons even an on-schedule borrower benefits from simple interest:
- Flexibility. Even small extra payments save real interest over the loan's life.
- Bi-weekly payments work. Splitting a monthly into two bi-weekly payments shaves real interest because the principal drops earlier.
- Refinance economics. If rates drop and you want to refinance, the payoff amount is the actual remaining principal — no "rebate" calculation eating into the math.
Precomputed loans punish flexibility. Simple-interest loans reward it.
Frequently asked
Are simple-interest loans always cheaper?
If you pay exactly on schedule, the total interest is the same as an equivalent precomputed loan. If you pay early or extra, simple interest is cheaper. Simple interest is never worse.
How do I know if my existing loan is precomputed?
Check your loan documents for the words "precomputed," "Rule of 78s," or "actuarial method." Or call your lender and ask: "Is this a simple-interest loan?" They have to tell you.
Are credit-union loans always simple interest?
Yes — virtually every credit union in the U.S. uses simple interest. Same for major banks and reputable online lenders.
Can I convert a precomputed loan to simple interest?
Not directly — but refinancing to a different lender accomplishes the same thing. Most refis are simple interest.