Rule of 78

The Rule of 78 is a method of allocating pre-computed interest to time periods. The total interest of a loan is pre-computed. This total interest is considered earned in proportion to the periodic time balances. The Rule of 78 provides a straight-line approximation of compound interest. This approximation is close where the term is short and the interest rates are low, but becomes increasingly biased in favor of early recognition of income as the interest rate and/or the term of the loan increases. The largest difference occurs about 1/3 of the way through a loan.

The Rule of 78 was designed solely for loans that are paid off with a series of equal payments equally spaced. For a loan payable in 12 equal installments, interest is allocated as follows: 12/78 of the interest is considered earned in the first month, 11/78 in the second, 10/78 in the third, and so on.

TValue also provides an extension of the Rule of 78 for cases where payments don't fit the regular pattern just described. In these cases, TValue automatically adjusts the interest allocation in proportion to the balances outstanding and the time that particular balances are outstanding. For example, if a loan is payable in 12 equal monthly installments but payments start two months from the loan date, 24/90 of the interest would be recognized with the first installment, 11/90 in the second, 10/90 in the third, etc. Accountants may recognize this as equivalent to the bonds outstanding method of recognizing interest on serial bonds.