Should you prepay your auto loans (rule of 78)?

[Voodooman]

https://m.sgcarmart.com/articles/articleinfo.php?CT=a&AID=61

Under 78 rule, it seems you will enjoy 80% interest rebate and the penalty is just 20% of unpaid interest but as auto loan charges interest upfront despite monthly declining loan balance, it can be difficult to figure out if you should prepay your auto loan half way into your loan term.  

My back of the envelope calculation shows the penalty is much higher than the 20% of unpaid interest (using actual instalments paid, redemption amount and pro rata interest cost).

The maths:

Assuming $100k 5 years loan at 2.5% flat with monthly instalments of $1875 and prepaid at the end of 30 months mark.

Total instalment paid over over first 30 months: $56.25k [$1875*30].

Loan prepaid at 30th month mark: 

Loan Redemption Amount: $54.73k

[calculation: original loan amount of $100k (+) upfront interest of $12.5k (-) installment paid of $56.25k (-) 80% rebate on unpaid Interest of $1.9k]

Implied 30 months Interest cost and prepayment penalty: $10.98k ([$100k (-) $56.25k (-) $54.73k].

Implied prepayment penalty, net of pro rated interest cost of $6.25k: $4.7k [$10.98k (-) $6.25k]. Equivalent to 4.7% of original loan amount. 

This translates into interest cost for next 23 months. In a nutshell, You are prepaying at Year 2.5 but paying all the way to Year 4.5. 

Better to let the loan run to maturity, unless your sparse cash is sitting in the bank and earning zero interest.  

Feel free to disagree with my agak agak methodology, which may not be entirely right. A DCF approach would be more accurate but I am no Excel wizard.

[Thaiyotakamli]

Yah not really worth

 

i redeemed my loan last year and still need pay 1% penalty fee. But now at least no debt haha

[yishunite]

Under most cases if u stick in mutual fund the cash for paying off the loan will earn more interest in mutual fund

If you think stocks are bad and mutual fund returns may be close to zero, swap and pay off loan for guarantee return

See risk appetite lor

*this post does not constitute financial advice 🤣

[Inlinefour]

tot DaiGor here all full cash one 

[Mkl22]

Makes sense if you pay back or redeem after 1year? Lazy to do the math

[AgentG]

It will make sense to redeem when there is no lock in period and no penalty when redeeming the car loan. If you can redeem a few days after the car loan was disbursed, the interest you pay will be much lower than the discounts given when buying a new car. 

Edited March 30, 2022 by AgentG

[Voodooman]

1 hour ago, Mkl22 said:

Makes sense if you pay back or redeem after 1year? Lazy to do the math

Might make more sense as there will be more “rooms” for saving, instead of paying up for nothing. Maybe that is why there are additional prepayment penalty during initial years. 

[Voodooman]

8 minutes ago, AgentG said:

It will make sense to redeem when there is no lock in period and no penalty when redeeming the car loan. If you can redeem a few days after the car loan was disbursed, the interest you pay will be much lower than the discounts given when buying a new car. 

The 78 rule favours the finance company, even if you prepay in a few days, the formula will work against you but better early than late. 

 

 

 

 

 

[Voodooman]

2 hours ago, yishunite said:

Under most cases if u stick in mutual fund the cash for paying off the loan will earn more interest in mutual fund

If you think stocks are bad and mutual fund returns may be close to zero, swap and pay off loan for guarantee return

See risk appetite lor

*this post does not constitute financial advice 🤣

That is a separate discussion.

If you have big risk appetite, you can borrow from loan sharks and still make money investing. Haven’t price in the risk. 

[AgentG]

18 minutes ago, Voodooman said:

The 78 rule favours the finance company, even if you prepay in a few days, the formula will work against you but better early than late.  

Take your example and if the person redeem the loan at the end of 1 month,

Loan amount = $100,000 5 years loan
Interest rate = 2.5% per annum
Total interest to be paid = (2.5% x 5 years x $100,000) = $12,500
Monthly instalment = ($100,000 + $12,500) / 60 = $1875
Number of instalments paid = 1 month
Total amount already paid for = $1875 x 1 = $1875
Unpaid interest according to Rule of 78 = [59(59+1)] / [60(60+1)] x $12,500 = $12,090.16

80% of unpaid interest = 0.8 x $12,090.16 = $9672

Loan redemption amount = $100,000 + $12,500 - $1875 - $9672  = $100,953

So if you taking a 5 year loan of $100000, you are paying a total of $100,953 + $1875 = $102 828 to redeem the loan at the end of 1 month.

So if new car discounts is more than $2 828, it is worthwhile to take the loan of $100 000 for 5 years provided no penalty and lock in period.

I hope my calculation above is correct.

Edited March 30, 2022 by AgentG

[CarGuy88]

That's some complicated math haha...

If the intention is to pay very early, would it be better to just nego at point of sale to waive off no-loan penalty (or rather still include the loan discount in the car price?)

Some dealers don't impose more for not taking loan, and some are willing to waive. There are probably enough alternative brands if the dealer of your first choice car doesn't wanna budge on this. 😬

[Hamburger]

No wonder I failed my math.... Damn it. 

[Voodooman]

8 minutes ago, CarGuy88 said:

That's some complicated math haha...

If the intention is to pay very early, would it be better to just nego at point of sale to waive off no-loan penalty (or rather still include the loan discount in the car price?)

Some dealers don't impose more for not taking loan, and some are willing to waive. There are probably enough alternative brands if the dealer of your first choice car doesn't wanna budge on this. 😬

Agree. 

 

17 minutes ago, AgentG said:

Take your example and if the person redeem the loan at the end of 1 month,

Loan amount = $100,000 5 years loan
Interest rate = 2.5% per annum
Total interest to be paid = (2.5% x 5 years x $100,000) = $12,500
Monthly instalment = ($100,000 + $12,500) / 60 = $1875
Number of instalments paid = 1 month
Total amount already paid for = $1875 x 1 = $1875
Unpaid interest according to Rule of 78 = [59(59+1)] / [60(60+1)] x $12,500 = $12,090.16

80% of unpaid interest = 0.8 x $12,090.16 = $9672

Loan redemption amount = $100,000 + $12,500 - $1875 - $9672  = $100,953

So if you taking a 5 year loan of $100000, you are paying a total of $100,953 + $1875 = $102 828 to redeem the loan at the end of 1 month.

So if new car discounts is more than $2 828, it is worthwhile to take the loan of $100 000 for 5 years provided no penalty and lock in period.

I hope my calculation above is correct.

Looks right. Lol

[yishunite]

21 minutes ago, AgentG said:

Take your example and if the person redeem the loan at the end of 1 month,

Loan amount = $100,000 5 years loan
Interest rate = 2.5% per annum
Total interest to be paid = (2.5% x 5 years x $100,000) = $12,500
Monthly instalment = ($100,000 + $12,500) / 60 = $1875
Number of instalments paid = 1 month
Total amount already paid for = $1875 x 1 = $1875
Unpaid interest according to Rule of 78 = [59(59+1)] / [60(60+1)] x $12,500 = $12,090.16

80% of unpaid interest = 0.8 x $12,090.16 = $9672

Loan redemption amount = $100,000 + $12,500 - $1875 - $9672  = $100,953

So if you taking a 5 year loan of $100000, you are paying a total of $100,953 + $1875 = $102 828 to redeem the loan at the end of 1 month.

So if new car discounts is more than $2 828, it is worthwhile to take the loan of $100 000 for 5 years provided no penalty and lock in period.

I hope my calculation above is correct.

5-yr loan very optimistic. Almost all now is 6-7 years standard.

What they dont tell u is every extra year they add your effective APR also up. But looks the same on paper since can stretch out the repayment. Ask to pay back in shorter time they die die wont allow cos APR goes down

So your only recourse is to repay early at your own decision. I think tho almost all loan got 12-18 mth lock in where early repayment got additional penalty on top so your scenario is doubly optimistic

[1fast1]

Basically, once you take the loan, you're screwed. It's only a matter of how much you can minimise the anal trauma with all that complicated math. 

The decision making is really quite straightforward. Or should be. 

If you *need* a car (for work), then get one you can buy without taking a loan. If even the cheapest car on the market needs you to become a debtor, well, just make sure it's really a need and not a want, disguised as a need. 

If you *want* a car, don't even think about loaning for one. 

That's it, really. 

Edited March 30, 2022 by Turboflat4

[Davidklt]

Feeling of owning a loan-free car...priceless.

[Heartlander]

44 minutes ago, AgentG said:

Take your example and if the person redeem the loan at the end of 1 month,

Loan amount = $100,000 5 years loan
Interest rate = 2.5% per annum
Total interest to be paid = (2.5% x 5 years x $100,000) = $12,500
Monthly instalment = ($100,000 + $12,500) / 60 = $1875
Number of instalments paid = 1 month
Total amount already paid for = $1875 x 1 = $1875
Unpaid interest according to Rule of 78 = [59(59+1)] / [60(60+1)] x $12,500 = $12,090.16

80% of unpaid interest = 0.8 x $12,090.16 = $9672

Loan redemption amount = $100,000 + $12,500 - $1875 - $9672  = $100,953

So if you taking a 5 year loan of $100000, you are paying a total of $100,953 + $1875 = $102 828 to redeem the loan at the end of 1 month.

So if new car discounts is more than $2 828, it is worthwhile to take the loan of $100 000 for 5 years provided no penalty and lock in period.

I hope my calculation above is correct.

You forgot to add in the 1 to 2% of loan principle as penalty charge. Then the amount would be correct.

 

Another way to see it is as per DBS website below:

Assume that you have a 5-year loan of $100,000 and you want to pay off your loan early after 1 months (i.e. after 1 instalment had already been paid):

Loan amount = $100,000
Loan period = 5 years originally
Interest rate = 2.50% p.a.
Total interest payable = (2.50% × 5 years × $100,000) = $12,500
Total amount owed = ($100,000 + $12,500) = $112,500
Instalments already paid (for 1 month) = ($112,500 / 60) × 1 = $1,875
Outstanding instalment amount = $112,500 - $1,875 = $110,625

Step 2: 20% of the interest rebate will be charged
20 percent of the interest rebate will be charged

Next, you need to calculate the interest rebate on your remaining loan period. Of this, 20% will be charged by the bank as a fee for early redemption.

The formula to calculate interest rebate is:
(n[n+1] ÷ N[N+1]) × Total Terms Changes
Where,
n refers to unexpired loan period in months;
N refers to original loan tenure in months;
Total Term Charges refer to the total interest payable

Based on the scenario above, interest rebate based on remaining 35 months*
= (59[59+1]) / (60[60+1]) × $12,500 = $12,090
20% bank fee = $12,090 × 20% = $2,418

Step 3: Add a 1% charge of the total financed amount
Calculate the balance when you redeem your loan early

Finally, there is a 1% charge on your total financed amount.

The total financed amount is calculated by taking the total cash price of the vehicle (including GST, the accessories, other related fees, expenses and charges) and deducting the total deposit including cash, allowance/trade-in for a used car model.

The balance payable when you redeem your loan early would then be
= Outstanding instalment amount - 80% of interest rebate + 1% of total financed amount
= $110,625 - ($12,090 - $2418) + $1000.00
= $101,953

This means you lugi $1953 +$1875 or $3828, provided you can redeem loan policy immediately after activate it without further penalty.

 

[AgentG]

1 hour ago, yishunite said:

5-yr loan very optimistic. Almost all now is 6-7 years standard.

What they dont tell u is every extra year they add your effective APR also up. But looks the same on paper since can stretch out the repayment. Ask to pay back in shorter time they die die wont allow cos APR goes down

So your only recourse is to repay early at your own decision. I think tho almost all loan got 12-18 mth lock in where early repayment got additional penalty on top so your scenario is doubly optimistic

My previous car loan taken 4 yrs ago from PML and offered by DBS offers early repayment without additional penalty albeit with a slightly higher interest rate.