A precomputed loan is a loan where the interest for the term is calculated when the loan is made. The interest is included in the account balance. Because interest is calculated when the loan is made and not as payments are made, the interest is “precomputed”.
A precomputed loan is made up of the amount borrowed (also called the amount financed), plus precomputed interest, plus any prepaid finance charges. Prepaid finance charges are loan fees charged in addition to interest. Examples include an origination fee and an administrative fee. The amount financed and loan fees are called the “principal”.
As payments are received, the account balance goes down by the amount of the payment. Payments are not applied separately to principal and interest because the account balance already includes both principal and interest.
If a precomputed loan is paid off early, all of the precomputed interest may not have been “earned”. The earned interest will be calculated based on how long it took to pay off the loan. The unearned interest is then refunded by subtracting it from the account balance. The payoff amount is the remaining account balance plus any unpaid fees and charges, like late charges.
There are different methods for calculating the interest refund. These include the Rule of 78s or the actuarial method. Prepaid finance charges are usually considered earned at the time of the loan, so there is no refund if the loan is paid off early. Refer to your loan agreement to see the method for calculating the refund and if you are entitled to a refund of prepaid finance charges.
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