Precomputed interest is calculated for a loan's scheduled term at origination and allocated across the contractual payments.
Precomputed interest is interest calculated for the scheduled loan term when the loan is originated and then included in or allocated across the contractual payments. Unlike simple interest calculated periodically on the actual outstanding principal, the scheduled finance charge is established in advance.
Early payoff may produce a rebate of unearned interest under the contract or applicable law, but the rebate method can allocate more interest to earlier payments. It is therefore inaccurate to assume either that early payoff never reduces interest or that the refund will match a simple-interest calculation.
In a basic add-on structure, total interest is calculated using original principal for the entire scheduled term:
Where:
If payments are level and monthly:
where (n) is the number of scheduled payments.
This arithmetic creates the payment schedule, but the quoted add-on rate is not the same as APR because the borrower repays principal throughout the term while the original balance was used to compute interest.
Assume a three-year installment loan has:
Precomputed interest is:
The scheduled total is:
The monthly payment is:
Although the add-on rate is 6%, the payment stream implies a monthly rate of about 0.9235%, or roughly 11.08% when multiplied by 12, before any other charges. The legally disclosed APR must be calculated under the applicable disclosure rules, but this comparison demonstrates why an add-on rate should not be compared directly with an amortizing simple-interest rate.
| Feature | Precomputed interest | Simple interest on declining balance |
|---|---|---|
| When scheduled interest is determined | At origination for the stated term | Over time using actual outstanding principal |
| Effect of early extra principal | May depend on allocation and rebate rules | Usually reduces later interest more directly |
| Quoted rate | May be an add-on or discount rate | Applied to actual outstanding balance |
| Early payoff | Requires calculation of earned and unearned charge | Stops future interest after payoff date, subject to terms |
| Main comparison measure | APR, finance charge, payment schedule, rebate method | APR, rate, payment schedule, and payoff timing |
Fixed-rate does not mean precomputed. A fixed-rate amortizing loan can calculate interest each period on declining principal while keeping the rate unchanged.
Using a one-year $1,000 credit request and a 6% precomputed charge:
Both use a $60 precomputed charge, but their proceeds and face amounts differ. Regulation Z’s official commentary uses similar examples to explain amount-financed disclosures.
The related Discounted Loan guide explains why a discount rate understates cost relative to the cash received.
At origination, the full scheduled finance charge has been computed, but not all of it has been earned by the lender. The unearned portion relates to the remaining scheduled term.
When a loan is paid early, the payoff calculation may rebate part of that unearned interest. Possible methods include actuarial allocation, a rule specified by statute or contract, or another permitted schedule.
The phrase Rule of 78s refers to a sum-of-digits allocation that assigns more of the scheduled finance charge to earlier periods. For a 12-month loan, the period weights total 78:
The first month receives 12/78 of the charge, the second receives 11/78, and so on. Because interest is front-loaded, an early payoff can rebate less than a straight-line allocation would. Whether this method is permitted depends on the loan and applicable law.
On a simple-interest loan, an extra principal payment generally reduces the balance used for later interest calculations. On a precomputed loan, the scheduled charge already exists. The servicer may apply an extra payment to future installments rather than immediately recalculate the charge, unless the contract or payoff rules provide otherwise.
Verify whether an extra payment:
Payment instructions and servicing records matter. A payment that advances due dates is not necessarily the same as a principal curtailment.
Suppose the $10,000 example loan is paid off after 12 of 36 scheduled payments. The borrower should not estimate payoff by subtracting 12 payments from $11,800.
The lender or servicer must determine:
Two loans with the same original payment can produce different payoff amounts if they use different rebate methods. Request a written payoff statement rather than relying on the payment schedule alone.
Review the contract and disclosures for:
Do not infer the method solely from equal monthly payments. Both precomputed and ordinary amortizing loans can have level payments.
The payment amount alone does not show how quickly principal declines or how much can be saved through early payoff. Compare:
For a borrower expecting to pay ahead of schedule, the payoff mechanics can be as important as the scheduled monthly payment.
This page provides general financial education. It does not calculate the legally required APR or payoff amount for a specific contract.