Most rebates are good for the consumer, and will save you money. However not all rebates are beneficial. In fact, there is a rebate called 'Rule of 78' that is tricky and actually represent a prepayment penalty.

What is the 'Rule of 78'?
There are two types of auto loans: simple interest loans and pre-computed loans. The Rule of 78 is a pre-computed loan. This means that the interest you are going to pay for your car loan is predetermined and that you are obligated to pay the entire amount of interest even if you pay your loan off early. 

A simple-interest loan is very different. You are only charged interest based on the amount that you owe, for the time that you owe. When you pay ahead on your loan, you save money on interest. There are no prepayment penalties.

When you pay ahead on a loan that applies the "Rule of 78s" method to prepayments you will be hit with a prepayment penalty, that will be disguised as a rebate.

Paying off your loan early
When you pay off your pre-computed loan early, you are going to be in for a big surprise. Lets says you settle your 48 month loan in 36 months. You expect to save money in interest right? Wrong! When the loan provider calculates what you owe by mean of the Rule of 78, you will owe more. This is because your lender will apply more of your previous payments to interest, and less to principal. So, since less has been applied to principal, you are going to owe more in principal when you look to settle your car loan early.

Rule of 78 is illegal in some states
Below is a list of states that do not allow the use of the Rule of 78s formula in car loans of five years and less:
Arizona
Delaware
Idaho
Iowa
Kansas
Michigan
Minnesota
Nebraska
Nevada
New Hampshire
New York
Maine Maryland
Massachusetts
Oregon
South Dakota
Vermont

Lenders that issue pre-computed loans that utilize the Rule of 78 formula are rare. However, if you have less than perfect credit, you should be aware that some lenders still grant pre-computed Rule of 78s auto loans. Note that Premier Auto Financing never issues pre-computed loans to anyone!

Another dealership trick to watch out for is 0% financing.

 

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