Assume a two-year loan (so we'll assume the numbers 1 through 24) for $10,000 with interest at 12% per year. Using a standard amortization calculator set to calculate interest at 1% per month (12% per year), the monthly payment is $470.73. If the calculator being used computes exact interest, the total amount of interest to be paid would be $1,297.65.
After the fourth month the borrower decides to prepay the whole loan. Under a standard amortization plan the borrower would have paid $377.61 in cumulative interest. However, using the Rule of 78 a lender would calculate the fraction of the total interest based on two series:
If you add 24, 23, 22 and 21, the sum is 90.
If you sum the numbers from 1 to 24, the sum is 300.
The fraction 90/300 = 30%. The lender will multiply this fraction by the total interest.
The calculation is (30%)($1,297.52) = $389.26
The difference between the amount paid under a standard amortization plan and the amount paid under a Rule of 78 plan is: $11.65.
