Let me try to illustrate.
Suppose you take a 10 year loan of $50,000 at 2% interest.
So the interest you owed the bank is $50,000x10yearsx2%
=$10,000
Add this to the sum you borrowed = $10,000+50,000= $60,000
So the amount you pay each month = $60,000/10 years/12 months =
$500
Let's now assume that you want to pay off the loan after 2
years
So you still owed the bank 8 years of repayment = $60,000 x 8 / 10
= $48,000
This is inclusive of a remaining interest of = $50,000 x 8 years x
2% = $8,000.
This is unfair to you because you are paying interest after you
terminated the loan. To make you "happy", the bank uses Rule 78 to
give you some "rebate".
The rebate formula is (Remaining
Interest) x n(n+1) / N(N+1)
where
n = remaining loan period (in months)
N = original loan period (in months)
So in the example, the remaining interest is $8,000, n=96 (8 yrs),
N=120 (10 yrs)
Therefore, the rebate is $8,000 x 96(96+1) / 120(120+1) =
$5,131
Rightfully, the rebate should be $8,000. But it's better than
nothing.
