Settling a loan early: how the Rule of 78 rebate works, with real numbers

What early settlement means on a flat-rate loan

On a flat-rate loan, all the interest is worked out on day one and added to the amount you repay. If you repay everything early, you haven't used the money for the full period, so it would be unfair to charge all of that interest. The law therefore requires licensed moneylenders to give you a rebate of the interest you haven't yet 'earned' for them.

The question is how much counts as unearned. You might expect it to be simple: settle halfway, get half the interest back. It isn't. Licensed lenders calculate the rebate using a method called the Rule of 78, and understanding it helps you decide when settling early is worth it. The same rule is used by banks for hire-purchase car loans, so what you learn here applies there too.

The Rule of 78, step by step

The Rule of 78 assumes more of the interest belongs to the early months of a loan, when you owe more, and less to the later months. It gets its name from a 12-month loan: number the months 1 to 12 and add them up, and you get 78.

1. 1

   Add up all the instalment numbers

   For a 12-month loan: 1 + 2 + … + 12 = 78. For 24 months it's 300; for 36 months, 666. The general formula is n × (n + 1) ÷ 2.

2. 2

   Add up the numbers for the instalments you haven't paid

   If 9 instalments remain on a 12-month loan, that's 1 + 2 + … + 9 = 45.

3. 3

   Divide, and multiply by the total interest

   Rebate = total interest × 45 ÷ 78. On RM1,200 of interest that's RM692.31.

4. 4

   Subtract the rebate from what you still owe

   Settlement amount = outstanding balance − rebate.

A full worked example

Take a RM10,000 loan at 12% flat over 12 months. Total interest is RM1,200, so you repay RM11,200 in total, and the monthly instalment is RM933.33. Here's what it costs to settle after three, six and nine instalments.

Settling after three months saves RM692.31 of interest. Settling after six saves RM323.08 — less than half as much, even though you're halfway through. Settling after nine saves only RM92.31.

The same rule on a longer loan

The pattern is the same for longer loans, only stretched out. Here's RM10,000 at 12% flat over 24 months: total interest is RM2,400, the instalment is RM516.67, and the sum of the instalment numbers is 1 + 2 + … + 24 = 300.

Settling a quarter of the way through gives back more than half the interest. Settling halfway gives back about a quarter. By three-quarters of the way, the saving is small. The lesson holds for any length of loan: if you're going to settle early, the sooner the better — and if you already know you'll have the money within a year, a shorter loan from the start may be cheaper still.

Why the saving shrinks so quickly

If interest were spread evenly across the loan, settling halfway would save half of it. The Rule of 78 instead treats the first month as carrying 12/78 of the interest, the second 11/78, and so on, down to 1/78 for the last month. That reflects the fact that you owe more early on, but it means early settlement is worth much more in the first few months than near the end.

When settling early is worth it

• You're in the first third of the loan, when the rebate is largest
• You'll still have an emergency fund afterwards — don't empty your savings to settle
• The money isn't needed for a debt that costs more, such as a credit card balance
• Settling frees up cash flow you genuinely need, for example before a drop in income

A useful test is to ask what would happen if an unexpected bill arrived the month after you settled. If the answer is that it would go on a credit card at 18% or more, keeping some of the money aside is usually the better choice, even if it means settling a little later or not at all. Clearing a loan only to start a more expensive debt saves nothing.

If you're near the end of the loan, the rebate is small and it often makes more sense to keep paying as normal and put the spare money towards savings or a more expensive debt.

How to settle with us

1. 1

   Ask for a settlement statement

   Call or WhatsApp us and tell us the date you want to settle. We'll prepare a written statement showing the balance, the rebate and the exact amount due on that date.

2. 2

   Pay into our company account only

   Transfer the amount to the company account named on your statement. Never pay a settlement into a personal account, whatever anyone tells you.

3. 3

   Get your settlement letter

   Once the payment clears, we issue a letter confirming the loan is fully settled. Keep it — it's your proof if anything ever appears wrongly on your credit record.

Questions

What to do next

If you're an existing customer thinking about settling, contact us for a settlement statement — there's no obligation to go ahead once you've seen it. If you're planning a new loan and expect to repay early, tell us when we call you about your enquiry; choosing a slightly shorter period from the start is often cheaper than settling early later.