Simple Interest vs Precomputed Interest: The 1% of Loans That Still Use the Latter

The setup

Two loans, both for $20,000 at "stated rate" 12% APR for 60 months.

Loan A (simple interest): Each month, the lender charges interest on the remaining balance. Your monthly payment goes partly to interest and partly to principal. By month 60, the balance is $0.

Loan B (precomputed interest): The lender calculates total interest at origination — about $6,667 — and adds it to the $20,000 principal to create a "total" of $26,667. Your monthly payment is $444.45 (= $26,667 / 60). Each payment is just $444.45, indistinguishable in structure.

If you make all 60 payments and never pay extra, the two loans cost the same. But if you pay off early, the math diverges sharply.

The early-payoff difference

Suppose you have $5,000 in month 30 and want to pay off the loan in full.

Simple interest payoff:

• Remaining principal in month 30: about $11,500
• Pay off: $11,500 + small amount of accrued interest for the partial month
• Total payoff: ~$11,560
• You've saved 30 months of future interest charges

Precomputed interest payoff:

• The lender uses a "Rule of 78s" or similar formula to refund some of the precomputed interest.
• Refund is structured to favor the lender: in month 30 of a 60-month loan, you've theoretically been "charged" more than half the total interest already (the formula treats early-month interest as larger).
• Total payoff: ~$13,200 (or so — depends on the specific rebate formula)
• The "savings" from early payoff are smaller than they would be on a simple-interest loan.

Same loan headlines, ~$1,640 difference at month-30 payoff. The borrower who didn't read the contract eats it.

What the Rule of 78s does

The "Rule of 78s" (or "sum of digits") is a method for calculating how much precomputed interest is "earned" by the lender at any given point in a loan's life. The math:

• For a 12-month loan: 12 + 11 + 10 + ... + 1 = 78. (Hence the name.)
• Month 1's interest = 12/78 of total interest = 15.4%
• Month 2's interest = 11/78 of total interest = 14.1%
• ...
• Month 12's interest = 1/78 of total interest = 1.3%

The borrower is treated as having "paid" front-loaded interest. If they prepay in month 6, the lender claims to have already "earned" 12+11+10+9+8+7 = 57 of the 78 units = 73% of total interest, even though 6/12 = 50% of the loan term has elapsed.

This isn't fraud. It's the contract. But it's deeply unfavorable to borrowers who pay off early — which is exactly what borrowers in good financial shape tend to do.

Where simple interest dominates

Every major personal loan lender we cover uses simple interest:

• SoFi, LightStream, Discover (prime tier)
• Upgrade, Best Egg, Upstart, LendingClub (mid-tier)
• OneMain, Achieve, Prosper (mid/sub-prime tier)
• Federal credit unions (universally)

If your loan is from any of these, you're on simple interest. Prepayment saves you future interest in the way the amortization tables in our other articles describe.

Where precomputed interest still appears

1. Subprime used-car loans arranged through dealerships. Increasingly rare, but exists.
2. Some "buy here, pay here" auto loans. Common.
3. Furniture, appliance, and HVAC financing. Sometimes.
4. Specialty/installment lenders like World Finance, Mariner Finance, and some "consumer finance" companies. Mixed — read the contract.
5. Older loan products that were originated 10+ years ago and are still amortizing.

If you're not sure, the question to ask is: "Is this loan simple interest or precomputed interest?" A legitimate lender will answer immediately and accurately. A lender that hesitates or gives a non-answer is a red flag.

Federal regulation

The federal Truth in Lending Act regulates how precomputed interest is disclosed but does not prohibit it. Many states have stricter rules — including outright bans on the Rule of 78s for loans over a certain term length — but enforcement is uneven.

The Military Lending Act applies stricter disclosure to loans made to active-duty service members.

How to verify your loan

1. Read your loan agreement. Look for the words "simple interest," "precomputed interest," "add-on interest," or "Rule of 78s."
2. Look at your monthly statement. If the statement shows a "principal balance" that decreases each month based on payments minus interest, you're on simple interest. If the statement shows a fixed total payoff that doesn't change with payments, you might be on precomputed.
3. Call the lender. Ask: "If I pay off this loan today, what's my exact payoff amount?" Compare it to the remaining principal under simple interest math. If the difference is more than a month's worth of interest, you're probably on precomputed.

The takeaway

In modern personal lending — SoFi, LightStream, Discover, and friends — simple interest is universal. You don't have to worry about this.

But if you're considering a loan from a less-recognized lender, especially in the subprime or specialty space, always ask explicitly. The wrong answer can cost you $1,000+ if you ever pay off early.