Let`s say you take out a 12-month loan that results in a total of $3,000 in interest charges. With the Rule of 78, here`s what a lender would charge you in interest each month: Refinancing an installment loan may make sense for a consumer in some cases, but certain market practices, such as charging high upfront fees and frontloading financing fees, disproportionately hurt those who do. Non-refundable issuance fees make the first few months of the loan more expensive for the consumer and the most cost-effective for the lender if the loan is repaid earlier. Many state laws even allow and encourage these practices, rather than requiring that monthly fees be spread evenly over the life of the loan and that the interests of lenders and borrowers be better aligned. Upfront fees provide a strong incentive for lenders to refinance loans in order to generate more of those lucrative first months. These results are broadly consistent with data published by states, which govern loan sizes, interest rates, fees, credit insurance sales, and other terms, although the rules – and therefore credit structures and costs – vary considerably from state to state.21 Eligible ELBs for small installment loans are generally much lower than for payday loans. but higher than for credit cards. South Carolina publishes detailed data on financing costs and loan sizes; The most commonly cited APR in this state is 107% for loans from $600 to $1,000 and 88% for $1,000.01 to $2,500.22 A chart of South Carolina interest rates from a large consumer credit company shows a total APR of 101% for a $738 loan with a 12-month term.23 Other state regulatory data shows the next cost and APR total for a $740 loan, which lasts 11 months: 294% and 72% in Alabama and Tennessee, 316% and 77% in Oklahoma, and 336% and 82% in Texas.24 This also explains the more moderate variation in issuance fees and associated fees for loans over $1,500, ranging from 1% to 12% of proceeds. For example, the highest issuance and maintenance fees in this study totalled $240 for a loan of $2,049, or 12% of the proceeds, and were paid by a borrower from Georgia. However, the same lender has issued loans in other states such as Kentucky and Alabama, with loan fees accounting for only 3% and 2% of revenue, respectively, suggesting that fees are determined by state boundaries rather than lender costs. Either way, it`s a good idea to read the details of a loan agreement before signing on the dotted line. This way, you can understand the details of how your loan accumulates interest and what your savings will look like if you decide to pay it off early. Also note the possible prepayment penalties.
This analysis also found that loans tend to cost less in states where interest rates plateau but prohibit by-products than in states that have caps of 36% or less, but allow the sale of insurance and other products.46 (see Figure 8). These findings suggest that when states set interest rate limits below which consumer credit companies cannot lend profitably, lenders sell loan insurance to generate revenue that they are not allowed to generate through interest or fees. Setting artificially low interest rate limits while allowing the sale of credit insurance increases costs to consumers while obscuring the magnitude of these increases. About 14,000 consumer credit companies operate nationwide, about half of which belong to the 20 largest domestic lenders.6 The nation`s largest consumer credit company operates more than 1,800 branches in 44 states.7 These domestic lenders offer small loans in 18 states,8 while large loans are available in the 44 states that allow installment loans. In general, southern states tend to allow higher prices and have more offers per capita. (See Figure 1 and Appendix A.) It is estimated that 10 million people spend more than $10 billion annually on these loans.9 These figures do not include installment loans from payday lenders or auto lenders, which are multi-payment loans made at much higher prices than the traditional installment loans described in this report.10 In one respect, however, the business models of payday lenders and auto title lenders and consumer credit companies. Both typically offer only a small number of products and their sources of income are not diversified: they rely heavily on existing borrowers to frequently refinance loans or borrow to generate income.34 This means that operating costs are spread among a relatively small number of borrowers per store, contributing to the high cost of loans.35 (see Figure 4). Consumer credit companies are slightly more efficient than payday lenders in this regard, serving more than 700 unique borrowers each year in an average location, compared to about 500 and 300 in payday title and auto stores, respectively.36 Consumer credit companies offer installment loans in 44 states to borrowers who typically have low credit scores.2 Although eligible financing costs vary widely in these states, 3 The prices of these loans are typically higher than banks or credit unions charge customers with higher credit ratings. Instalment loans range from about $100 to over $10,000, are repayable in four to 60 monthly installments, and can be secured – meaning the borrower provides collateral such as a car title or personal property – or unsecured.4 The market is divided between lenders that offer mostly small loans under $1,500 and those that offer mostly large loans.5 „Setting interest rate limits At the same time, allowing the sale of credit insurance increases costs for consumers. while obscuring the magnitude of these gains. It is important to understand what type of financing will be applied to your loan repayment schedule, especially if you intend to repay the loan sooner. The interest rate structure of Rule 78 favours the lender over the borrower in many ways.
The good news is that more lenders use a simple interest rate formula than the Rule of 78, and some states have banned this unbalanced interest rate formula altogether.
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