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Rule of 78s
Also called sum of the digits method, sum-of-the-digits rebate, precomputed interest allocation.
A method of allocating precomputed interest across a loan's payments so that far more is treated as earned in the early months, which shrinks the rebate you receive if you pay off early.
Drafted with AI assistance and checked by a person. Its factual claims were verified against the sources listed at the end, by Find Me Funders research desk.
What it means
The name comes from a twelve-month loan: 12 + 11 + 10 + … + 1 = 78. Month one is allocated 12/78 of the total interest, month two 11/78, and so on down to 1/78 in the final month. The same logic scales to any term.
Where it applies
Only to precomputed or add-on interest structures, where the total of payments is fixed at signing. There is no way to apply it to a simple-interest loan, because there is no precomputed interest to allocate. If your document shows a fixed total of payments and a rebate clause, the rebate method is worth finding.
What it does to an early payoff
The payoff is the remaining scheduled payments minus the unearned interest. Under this method the unearned portion is smaller than it would be under an actuarial calculation, so the payoff is higher. The divergence is largest around the middle of the term and grows with term length — negligible on twelve months, meaningful on sixty.
Where it is restricted
It is limited for consumer credit. A federal provision prohibits Rule of 78s rebates on consumer credit transactions with terms exceeding 61 months, and state statutes restrict or prohibit it further in consumer contexts. Commercial credit is a different matter. Business loans, some equipment paper and older retail instalment contracts have used it, and state rules for commercial transactions vary. Do not assume a business borrower is protected.
How to spot it
An add-on or precomputed structure, plus a rebate clause naming the Rule of 78s, the sum of the digits, or a method described by formula rather than as the actuarial method.
Where this one catches people
The pitch is "pay it off any time, there's no prepayment penalty", and that can be literally true while an early payoff still costs you far more than you expect. There is no penalty. There is simply much less rebate than the halfway point suggests, because most of the interest was allocated to the months that have already passed.
Before signing anything with a fixed total of payments, ask one question in writing: if I pay this off in full at month N, what is the exact payoff figure? Ask it for two or three values of N. Then compare those figures with what a simple-interest amortisation of the same amount would leave outstanding at the same points. The gap is the real price of the structure, and it will not appear anywhere in the rate discussion.
Worked through
Illustrative. 60,000 financed over 60 months with 21,000 of precomputed add-on interest. Total of payments 81,000; monthly payment 1,350.
Sum of the digits for 60 months: 60 × 61 ÷ 2 = 1,830.
Pay off at month 30. Interest allocated to months 1 to 30 is the digits 60 down to 31, which sum to (60 + 31) × 30 ÷ 2 = 1,365. So the earned interest is 1,365 ÷ 1,830 × 21,000 = about 15,664. The unearned rebate is 21,000 − 15,664 = 5,336.
You have paid 30 × 1,350 = 40,500. Remaining scheduled payments: 40,500. Payoff: 40,500 − 5,336 = 35,164.
So halfway through the term you have paid 40,500 and still owe 35,164 on a 60,000 loan. Exiting at the midpoint saved 5,336 of the 21,000 interest — about a quarter of it, for giving up half the term.
For comparison, a simple-interest loan with the same 1,350 payment implies a rate of roughly 12.5 percent a year, and its balance at month 30 would be about 34,600. The Rule of 78s costs about 500 more at that point. The structural loss is real but modest; the expectation gap is the expensive part.
Figures in the example are illustrative. They show the arithmetic, not a quote — what any one lender would charge is on that lender's page, where it is published at all.
Where you will meet this term
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Sources and checks
Every figure on this page traces to a document someone read, on a date. Where a check is past its review date it says so rather than passing as current.
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every figure in the sum-of-the-digits worked example recomputes exactly: 1,830 digits, 1,365 allocated to months 1-30, 15,664 earned, 5,336 rebate, 35,164 payoff
example81,000 / 60 = 1,350 a month. Sum of digits for 60 months = 60 x 61 / 2 = 1,830. Digits 60 down to 31 = (60 + 31) x 30 / 2 = 1,365. Earned interest = 1,365 / 1,830 x 21,000 = 15,663.93. Rebate = 21,000 - 15,663.93 = 5,336.07. Paid to date = 30 x 1,350 = 40,500; remaining scheduled = 40,500; payoff = 40,500 - 5,336.07 = 35,163.93. Rebate as a share of interest = 5,336 / 21,000 = 25.4%, i.e. 'about a quarter'.
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the simple-interest comparison also recomputes: a 1,350 payment on 60,000 over 60 months implies 12.50% a year and a month-30 balance of 34,628, about 536 below the Rule of 78s payoff
exampleSolving 60,000 = 1,350 x (1-(1+i)^-60)/i gives i = 1.0420% a month; x 12 = 12.504% nominal annual, matching 'roughly 12.5 percent'. Balance after 30 payments = 1,350 x (1-(1+i)^-30)/i = 34,627.52, matching 'about 34,600'. 35,163.93 - 34,627.52 = 536.41, consistent with 'about 500 more'.
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a federal provision does restrict Rule of 78s rebates on consumer credit transactions with terms exceeding 61 months, and does not reach commercial credit
definition15 U.S.C. s 1615(b): 'For the purpose of calculating any refund of interest required under subsection (a) for any precomputed consumer credit transaction of a term exceeding 61 months which is consummated after September 30, 1993... the creditor shall compute the refund based on a method which is at least as favorable to the consumer as the actuarial method.' Because the Rule of 78s is less favorable than the actuarial method, the effect is prohibitive for covered transactions; the section applies only to consumer credit, supporting the entry's warning that business borrowers should not assume
Rule of 78s — common questions
What does rule of 78s mean?
A method of allocating precomputed interest across a loan's payments so that far more is treated as earned in the early months, which shrinks the rebate you receive if you pay off early.
Where does rule of 78s catch people out?
The pitch is "pay it off any time, there's no prepayment penalty", and that can be literally true while an early payoff still costs you far more than you expect. There is no penalty. There is simply much less rebate than the halfway point suggests, because most of the interest was allocated to the months that have already passed.
Is rule of 78s the same as an interest rate?
Rule of 78s is defined above; if you are comparing it against a rate, check whether the two measures share a time dimension before you put them side by side.
Which products does rule of 78s apply to?
Working Capital, Term Loan, Equipment Financing.
Is there a worked example of rule of 78s?
Yes, on this page, and it is labelled illustrative. It shows the arithmetic, not a quote from any lender.
What else should I read alongside rule of 78s?
Add-on interest, Amortization, Early payoff discount, Interest rate, Payoff quote.
Has this definition been checked?
Yes. Its claims were verified against the sources listed at the end of this page, and the reviewer is named.
Is this legal advice?
No. It is a definition. What a clause does in your contract, in your state, is a question for a lawyer licensed where you are.
Can I suggest a term?
Yes — [email protected]. The glossary grows from what people are actually shown in contracts.