For consumers with poor credit it may be difficult to predict what interest rate they will receive but we can tell them which type of interest to avoid
Interest charges and bad credit
Usually one of the first questions we get from car buyers with questionable credit is what interest rate they’ll be required to pay on an auto loan. And while that usually can’t be predicted, borrowers rarely ask what type of interest rate it is – something that could be equally as important.
We know this because here at Auto Credit Express we’ve been helping car shoppers with problem credit looking for online car loans find those new car dealerships that can give them their best opportunities for car loan approvals.
The fact is that while the types of interest rates aren’t usually considered to be important by most buyers, knowing the kind of interest rate the loan specifies can make a big difference especially for consumers with bad credit. That’s because the type of interest not only affects the amount of interest paid over the loan term, it’s also important if there’s a chance the vehicle will be traded in before the end of the loan.
The most common type of vehicle loan is the simple interest auto loan. With a simple interest loan the interest is charged on the daily loan balance.
This means that if a payment is made before the due date or if more than the amount due is paid (early payment, overpayment), less interest will accrue. The reason for this is that the running balance, on which interest charges are computed, will be lower. In a way, simple interest loans reward those who pay early or overpay as these borrowers will pay lower interest charges over the loan term.
Also, if the loan is paid off early, the interest expenses stop at that time with no further interest accumulating on the loan. This means that loan payoff amount at any point in the loan is the original loan amount, plus the interest charges to date, minus the payments made. There is no interest penalty and borrowers stop paying interest the moment the loan is paid even if it’s paid off early.
Rule of 78s interest
Most consumers aren’t familiar with another type of interest, the rule of 78s, simply because this method is not used nearly as much as it once was.
With the rule of 78s, the amount of interest to be charged on the loan is computed beforehand and calculated by using amortization tables. Once the interest charge has been determined, a portion is then built into each payment. Because of the way amortization works, typically ¾ of the interest charges are paid during the first half of the loan. Because the monthly payment never changes and the interest is “front-loaded”, if the loan is paid off early the payoff amount at that time is usually higher than that of a simple interest loan.
Although lenders w typically “rebate” a portion of the pre-computed interest charges in an early payoff of a rule of 78s loan, borrowers still end up paying more in interest charges than a similar simple interest loan.
In 1992, the use of rule of 78s interest for all closed-end loans (those with a fixed final payment date) over 61 months in length was declared illegal. Arizona, Delaware, Idaho, Iowa, Kansas, Maine, Maryland, Massachusetts, Michigan, Minnesota, Nebraska, Nevada, New Hampshire, New York, Oregon, South Dakota and Vermont have also outlawed this type of interest computation in loans with terms of 61 months or less.
Currently, most lenders offer only simple interest loans. However, a handful of high-risk auto lenders dealing with really bad credit borrowers as well as many buy here pay here dealers and tote the note car lots in the remaining states that still allow it can use the rule of 78s to compute the interest charges for their auto loans.
Spotting a rule of 78s loan
To spot a rule of 78s loan, be sure to read the finance contract carefully. If it has the words “refund” or “rebate of interest” or if the wording in the “prepayment” section states anything other than “no penalty”, it isn’t a simple interest contract. In this case borrowers should avoid signing it, if possible.
The Bottom Line
When it comes to auto loans for credit-challenged consumers, it’s not just the interest rate but also the type of interest that can end up costing borrowers more money. To avoid accidentally signing a rule of 78s loan, look over any finance contract carefully.
One more thing to think about: at Auto Credit Express we match applicants that have experienced car credit problems with dealers that can give them their best chances at approved car loans.
So if you’re ready to reestablish your auto credit, you can begin now by filling out our online car loan application.
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