While paying off a loan early can lessen the finance charges you pay, you may still owe more than you think you should. This often happens because creditors typically set up your repayment plan where you pay larger monthly interest payments early in your loan using the "Rule of 78s" -- or the sum of the digits -- to calculate finance charges. Using this rule, the lender adds the number of payments in the repayment plan to determine how much interest the borrower pays each month. For example, a 12-month repayment plan divides the interest into 78 parts. The first month, your payment pays 12/78s of the loan's interest.
Add the numerical values for all of the months in your repayment term. For example, if you have a 12-month loan, add 1+2+3+4+5+6+7+8+9+10+11+12 = 78.
Calculate the interest you will pay over the life of the loan using the formula I = R x T, where I = interest, R = rate and T = time. If you borrowed $10,000 at 4 percent interest for one year, replace the letters in the formula with the numbers from your loan. For example, 0.04 x 1 x $10,000 = $400. If you take 12 months to repay the loan, you will repay the lender $10,400 with 11 payments of $866.67 and 1 payment of $866.63.
Use the formula (U x (U+1)) / (T x (T + 1)) = X x F = rebate, where U is the unearned term periods, T is the term periods, X is the Rule of 78s decimal and F is the finance charge. For example, if you decide to pay your loan off in three months instead of 12, the formula is (9x(9+1)/(12(12+1) = 0.5786. Multiply 0.5786 by $400 to find your finance charge refund of $231.44
The value for the Rule of 78s is not always 78. For example, if you are to repay your loan over two years, use the number 300 instead of 78.
Loans with a repayment term of 60 months or longer cannot use the Rule of 78s when calculating interest payments. Read your loan agreement to make sure that you are eligible for a refund if you repay your loan early.