Rule of 78

What is the Rule of 78?

The Rule of 78 is a method for allocating interest charges across a loan's payment schedule. Instead of calculating interest daily on the remaining balance, the total interest for the loan is precomputed at origination, then divided unevenly across payments, weighted heavily toward the beginning of the loan term.

The name comes from a 12-month loan: adding the digits 1 through 12 equals 78, the denominator used to calculate each month's share of interest.

How the Rule of 78 works

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• The total interest for the loan is calculated in advance, before the first payment
• Each payment period is assigned a weight, starting with the highest weight in month one and decreasing each month
• For a 12-month loan, month one carries 12/78 of the total interest, month two carries 11/78, and so on down to 1/78 in the final month
• Because more interest is allocated to earlier payments, a borrower who pays off the loan early ends up having paid a larger share of the total interest than they would under a different method

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Rule of 78 vs. simple interest

Simple interest is calculated on the remaining principal balance each period. As the balance goes down, so does the interest charged, and a borrower who pays off the loan early saves a proportional share of interest.

The Rule of 78 doesn't work this way. Because interest is precomputed and front-loaded, paying off the loan early saves less than a borrower might expect, since a larger share of the total interest was already allocated to the payments made so far.

If a loan runs its full term, the total interest paid ends up roughly the same under either method. The difference only shows up with early repayment.

Legal status and restrictions

The Rule of 78 is restricted at the federal level. Under Section 933 of the Consumer Credit Protection Act, the method cannot be used for loan terms longer than 61 months. It's also prohibited for mortgages.

Beyond federal restrictions, many states impose their own limits or bans on the Rule of 78 for consumer credit, and these rules vary and change. Lenders should confirm current requirements in every state where they operate before using this method on any loan product.

Why some lenders still use it

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Given the restrictions and the borrower-unfavorable optics, the Rule of 78 has become far less common than simple interest. Where it still shows up:

• Servicing legacy loan portfolios originated under this method, often the case when migrating older loan books onto a new platform
• Short-term consumer installment loans, such as certain auto loans, in states where the practice remains permitted

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Bottom line

The Rule of 78 is a legal, but increasingly restricted and less common, method of allocating loan interest. Its use is heavily dependent on loan term length and state law, so lenders considering it should treat compliance confirmation as a first step, not an afterthought.

LoanPro supports the Rule of 78 as one of four configurable interest calculation types, alongside simple interest, simple interest locked, and interest-only, giving lenders flexibility to match the calculation method to a specific loan product or legacy portfolio requirement.

Disclaimer: This article is for general informational purposes and does not constitute legal or compliance advice. Lending regulations vary by state and change frequently. Consult qualified legal counsel to confirm compliance requirements before implementing any interest calculation method.