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The Rule of 78: How to Avoid a Pre-Computed Loan Debt Trap

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It’s best to review all aspects of your company before applying the Rule of 78 to your annual business plan. Once you’ve examined the right target to achieve your goals, then the Rule of 78 can help illustrate the most practical means to reach it. It is a method of calculating and applying interest on a loan that allocates a larger portion of the interest charges to the earlier loan repayments. It is seen as unfair to borrowers who decide to pay their loans off early. It becomes a little more complicated to estimate and calculate revenue when you have multiple revenue streams, and especially when you offer monthly recurring billing options to your customers.

The Rule of 78 approach is different from the more commonly used simple-interest method, which applies your interest rate consistently throughout the duration of your loan. Instead, using the Rule of 78, a lender precomputes the amount of interest you’ll pay on your loan over its full term. Then, it charges a higher proportion of this amount at the beginning of your loan term than at the end.

Financial analysts believe the Rule of 78, also known as “pre-computed loans” is unfair to consumers because it penalizes anyone who pays off a loan early, though the penalty is really not that severe. The sum of all the digits between one and 12 is 78 — hence, the rule of 78. So in the case I’ve just described, the business in question would ultimately generate $78,000 in revenue over the calendar year. If you bring on one customer in January, you can expect to see $12,000 in revenue from them in the calendar year. Then, if you bring on another customer in February, you can expect to see $11,000 from them in revenue for the year.

Obviously, in real life you’re never going to retain 100% of the customers you convert during the year. Basically, take the price of your product, multiply it by the number of customers you want to add each month and then multiply it again by 78 to get a ‘best case scenario’ idea of your revenue for the year ahead. If none of your income relies on recurring sales, the Rule of 78 isn’t going to help you. Find out how much you need to bring in each month to achieve your goals. Interest is the monetary charge for the privilege of borrowing money, typically expressed as an annual percentage rate. Ultimately, the rule of 78 is a convenient, if flawed, way to quickly estimate your annual revenue for a variety of purposes.

A Brief Guide to Sales Methodologies

Unlike the Rule of 78, a lender applies the same rate to your principal balance to determine interest charges each month. The amount of interest you must pay will still decrease each month as your principal debt shrinks, but you won’t have to pay a disproportionate amount at the beginning. Let’s imagine that your sales team has five members and you want them to bring in $100,000 in a 12-month period selling $50 subscriptions. It’s easy to see that in this scenario each member of the team should bring in about $20,000 in a year.By dividing that goal by 78 we get $256 (let’s round it down to $250).

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Paying off a loan ahead of schedule can save you money on interest charges. But if your lender uses the Rule of 78, your interest savings might be less than you expect. A loan of $3000 can be broken into three $1000 payments, and a total interest of $60 into six. During the first month of the loan, the borrower has use of all three $1000 (3/3) amounts. At the end of the month, the borrower pays back one $1000 and the $30 interest. During the second month the borrower has use of two $1000 (2/3) amounts and so the payment should be $1000 plus two $10 interest fees.

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On March 15, 2001, in the U.S. 107th Congress, U.S. Rep. John LaFalce (D-NY 29) introduced H.R. 1054, a bill to eliminate the use of the Rule of 78s in https://bookkeeping-reviews.com/ transactions. The bill was referred to the House Committee on Financial Services on the same day. On April 10, 2001, the bill was referred to the Subcommittee on Financial Institutions and Consumer Credit, where it died with no further action taken.

However, because the Rule of 78 weights the earlier payments with more interest than a simple interest method, paying off a loan early will result in the borrower paying slightly more interest overall. The Rule of 78 allocates pre-calculated interest charges that favor the lender over the borrower for short-term loans or if a loan is paid off early. The Rule of 78 can be traced back to Indiana in 1935, immediately after the Great Depression. Lenders were typically doling out smaller amounts to borrowers over a period of 12 months with the unearned portion of the loans’ interest calculated at the time of disbursement of funds. On a simple interest loan, the amount of interest is amortized each month, meaning the amount of interest paid each month changes because it’s based on the amount of principal, which declines with each payment. The Rule of 78 is a financing method that allocates pre-calculated interest charges that favor the lender over the borrower onshort-term loans.


By the third month the borrower has use of one $1000 (1/3) and will pay back this amount plus one $10 interest fees. If a borrower plans on repaying the loan early, the formula below can be used to calculate the unearned interest. The rule of 78 concerns the revenues you’ll gain in a 12-month period, but the same equation actually holds up for longer stretches of time. The customers you bring at the beginning of the year are more important for hitting the yearly sales goal than the customers you bring in at the end of the year. One of the main ideas behind the rule of 78 is that customers you bring at the beginning of the year will be worth more to you by the end of the year than the customers you bring during the later months. Even if that person on your team continues to hit their quota of 25 new customers for the rest of the year, they won’t be able to recoup those 8 months of lost revenue.

Time Value of Money

Instead of settling for a normal consultant practice that provides a written plan or guide, we go the extra mile to add value to every stage of our services. When you partner with us, we help develop strategies that work best for your organization, and will work with you through every step of the implementation process. Simply put, the Rule of 78 determines how much a business needs to make in recurring sales every month in order to remain financially stable. This method above would be called ‘rule of 6’ (achieved by adding the integers 1-3), but because most loans around 1935 were for a 12 month period, the Rule of 78s was used. Once you understand the Rule of 78, you understand why salespeople are so busy at the beginning of the year. Sales made in January will have 12 months of billing for the year; whereas sales made in July will only have 6 months of billing in the current year.

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Whether your lender uses the Rule of 78 or a simple-interest formula, you’ll pay a total of $275 in interest charges over the year. But on a Rule-of-78 loan, your first month’s interest charges would be $42.30. On a simple-interest loan, your first month’s interest charges would be slightly lower at $41.67. Lenders more commonly use a simple-interest formula to apply interest charges to a loan.

This effective tool ensures you meet your margin requirements while speeding pricing activities. If you divide the annual rate by 12 you can calculate a monthly interest rate. The Rule of 78 is used to calculate a borrower’s interest refund for paying back a credit product early.

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This is how much revenue each member of the team should bring in each month by closing new accounts. The difference in savings from early prepayment on a Rule of 78 loan versus a simple interest loan is not significantly substantial in the case of shorter-term loans. For example, a borrower with a two-year $10,000 loan at a 5% fixed rate would pay total interest of $529.13 over the entire loan cycle for both a Rule of 78 and a simple interest loan. The Rule of 78 methodology gives added weight to months in the earlier cycle of a loan.


In other words, you would pay 12/78 of the interest the first month; 11/78 of the interest the second month and so on down to 1/78 of the interest the final month. Calculate average deal size, win-loss rate, churn rate, and more.

The formula is calculated by taking the number of customers and dividing them by the average service price. The Rule of 78 structures interest and payments such that borrowers pay more interest at the beginning of a loan and pay less in interest as they pay down their debt. If you are far along in the debt repayment process, the Rule of 78 may reveal that paying off your loan early won’t save you that much money. One possible way to solve this dilemma is to augment common cloud measures such as MRR and ARR with derivative measures such as territory revenue. By setting a territory revenue quota based upon a desired timing of bookings, you can incent the behavior you are trying to drive. However, this approach does not come without its own set of challenges.

month to achieve

The GoCardless content team comprises a group of subject-matter experts in multiple fields from across GoCardless. The authors and reviewers work in the sales, marketing, legal, and finance departments. All have in-depth knowledge and experience in various aspects of payment scheme technology and the operating rules applicable to each.

Curbside alcohol sales allowed but no ‘drinks to go,’ ABC says; 78 state-owned liquor stores close – AL.com

Curbside alcohol sales allowed but no ‘drinks to go,’ ABC says; 78 state-owned liquor stores close.

Posted: Sun, 29 Mar 2020 07:00:00 GMT [source]

For example, if you had a 12-hot sauce of the month club loan, you would add the numbers 1 through 12 (1+2+3+4, etc.) which equals 78. Lenders who promote this method are usually involved in sub-prime, used automobile business. Dealerships that advertise “Buy Here, Pay Here” financing are prime locations. If you hear salesmen mention things like “refund” or “rebate of interest” when discussing loan terms, be skeptical about what comes next.

When she’s not reporting on all things personal finance, Rebecca teaches blogging and SEO strategies on her website, remotebliss.com. Either way, it’s a good idea to read over the details of any loan agreement before you sign on the dotted line. That way, you can understand the details of how your loan accrues interest and what your savings will look like if you decide to pay it off early. Although the Rule of 78 can lead to higher interest charges at the beginning of your loan, it won’t cost you more overall if you stick with your original loan term. This rule can be problematic, however, if you choose to pay off your loan early.

If you own a gym, you know how many new members you need to recruit every 30 days. Learn how personal loan interest rates work, how rate types differ, and what the average interest rate is on a typical personal loan. Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas’ experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning. Browse around on the Internet so you know where to go for your loan and what to expect. Knowing all your options will help you make a sound financial decision.


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