Download Chapter 12 Business and Consumer Loans Section 3

Chapter 12
Business and
Consumer Loans
Section 3
Early Payoffs
of Loans
Copyright © 2015, 2011, and 2007 Pearson Education, Inc.
1
Objectives
1.
2.
3.
Use the United States Rule for an early
payment.
Find the amount due on the maturity date
using the United States Rule.
Use the Rule of 78 when prepaying a loan.
Copyright © 2015, 2011, and 2007 Pearson Education, Inc.
2
Use the United States Rule for an Early
Payment
Common for a payment to be made on a loan
before it is due
Example: Refinance a debt to a lower rate
Rule used by U.S. government and most states
and financial institutions
Payment first applied to any interest owed
Balance is used to reduce principal
Copyright © 2015, 2011, and 2007 Pearson Education, Inc.
3
Using the United States Rule
Step 1 Find the simple interest due from the date
the loan was made until the date the
partial payment is made. Use the formula
I = PRT.
Step 2 Subtract this interest from the amount of
the payment.
Step 3 Any difference is used to reduce the
principal.
Copyright © 2015, 2011, and 2007 Pearson Education, Inc.
4
Using the United States Rule
Step 4 Treat additional partial payments in the
same way, always finding interest on only
the unpaid balance after the last partial
payment.
Step 5 The remaining principal plus interest on
this unpaid principal is then due on the
due date of the loan.
Copyright © 2015, 2011, and 2007 Pearson Education, Inc.
5
Find the Amount Due on the Maturity
Date Using the United States Rule
If the partial payment is not large enough to pay
the interest due, the payment is simply held until
enough money is available to pay the interest due
This type of partial payment offers no advantage
to the borrower
Copyright © 2015, 2011, and 2007 Pearson Education, Inc.
6
Example
Page 484
Quick Check 2
Copyright © 2015, 2011, and 2007 Pearson Education, Inc.
7
Use the Rule of 78 when Prepaying a
Loan
Rule of 78 allows a lender to earn more of the
finance charge during the early months of the loan
compared with the United States Rule
Lenders typically use this rule to protect against
early payoffs on small loans
Effectively, the lender will earn a higher rate of
interest in the event of an early payoff
Copyright © 2015, 2011, and 2007 Pearson Education, Inc.
8
Rule of 78
Based on a loan of 12 months
Sum of the months 1 + 2 +3 +…+ 12 = 78
Finance charge:
first month is 12/78 of the total charge
11/78 in the second month
10/78 in the third month
and so on …
1/78 in the final month
Copyright © 2015, 2011, and 2007 Pearson Education, Inc.
9
Unearned Interest
Total finance charge on an installment loan is
calculated when a loan is first made
Early payoff of a loan results in a lower finance
charge
Portion of the finance charge that has not yet been
earned by the lender under the Rule of 78 is
called unearned interest or refund
Copyright © 2015, 2011, and 2007 Pearson Education, Inc.
10
Finding Unearned Interest
 N   1 N 
U  F  

 P   1 P 
where
U = unearned interest
N = number of payments remaining
F = finance charge
P = original number of payments
Copyright © 2015, 2011, and 2007 Pearson Education, Inc.
11
Example
Page 487
Problem 8
Copyright © 2015, 2011, and 2007 Pearson Education, Inc.
12