Simple vs precomputed interest
Two methods for calculating loan interest that determine whether paying off your loan early actually saves you money.
What it means
Simple interest loans calculate interest daily on your remaining principal balance. Pay extra or pay early, and you save on interest. Most bank and credit union auto loans use simple interest. Precomputed interest loans calculate the total interest you'll pay over the full loan term upfront, then add it to the principal. Your payment covers a fixed blend of principal and interest each month. Paying early may earn you a partial rebate, but you won't save as much. Precomputed loans are common with buy-here-pay-here dealers and subprime lenders.
Why it matters
With simple interest, every extra dollar goes directly to principal and reduces future interest charges. With precomputed interest, you've already agreed to pay most of the interest regardless of when you pay off the loan. If you plan to refinance, trade up in two years, or make extra payments, a precomputed loan costs you significantly more. Some precomputed loans use the Rule of 78s, an outdated method that front-loads interest and punishes early payoff even further.
What to do
Before you sign, ask whether the loan uses simple or precomputed interest. If you already have a precomputed loan and rates have dropped, calculate whether refinancing into a simple-interest loan saves you money using our refinance verdict tool.
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