Rule 78: The car loan secret banks won't tell you

Last Updated on August 14, 2025 by Chin Yi Xuan

Ever wonder WHY most people who are good with money will not pay off their car loan early?

Instead, they’ll use the extra money to invest or pay off a house loan.

This is because they understand this secret rule on how banks calculate interest on car loans:

This secret rule is called the Rule of 78

It’s a practice banks use to calculate interest, usually in car and personal loans.

Rule of 78 *front-loads* the interest, meaning you pay more interest in the early months and less toward the end.

Example: You take a 5-year (60 months), RM50,000 car loan at 3% p.a. interest.

How most people think interest is being charged:

In reality, the Rule of 78 ensures maximum interest is paid at the start:

This reduces savings from the early loan repayment for borrowers.

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Try this: How much interest you’ll save from early repayment:

So, let’s say you are considering paying off your car loan early, how much interest do you actually save?

Scenario: You take a 5-year (60 months), RM50,000 car loan at 3% p.a. interest.

➡️ Step 1: Calculate the total interest charged for your car loan

• RM50000 x 3% p.a. x 5 years = RM7500

➡️ Step 2: Calculate your monthly installment

Car loan + Total Interest ➗ Loan Tenure = Monthly Installment

• (RM50000 + RM7500) ➗ 60 months (ie. 5 years) = RM958.33/month

➡️ Step 3: Calculate your Outstanding Loan after 36 months

Car loan + Total Interest – Total installment = Outstanding Loan

• RM57500 – (36 x RM958.33) = RM23,000

➡️ Step 4: Now, let’s find out how much interest you’ll save from this early repayment

This is also called a ‘Rebate’.

Let’s calculate how much rebate you will get:

n = Periods of tenure left, N = Total tenure period, TC = Total interest charged

• [(24 x 25) ➗ (60 x 61)] x RM7500 = RM1,229 saved ✅

➡️ Step 5: What’s the FINAL amount you need to pay for early repayment?

Outstanding loan – Rebate = Amount required for repayment

• RM23,000 – RM1,229 = RM21,771

➡️ Step 6: Finally, let’s see how much interest you have paid by the end of Year 3 (Month 36):

Total Interest – Total Rebate = Interest Paid

• RM7500 – RM1229 = RM6271

By Year 3, you’d have paid 84% (RM6271) of your interest.

This means your savings (RM1,229) from early repayment is not as significant as you may think:

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What’d be a better choice? Settling a car loan early or investing the cash?

For this, we’ll compare 2 things:

(A) The ‘cost’ of keeping a RM23,000 car loan:

Not settling my car loan early means I’ll have to pay a total of RM1,229 in interest over the next 2 years.

As long as my investment generates a return that is larger than RM1,229 – it makes sense to invest rather than pay off the car loan early.

Let’s take a look:

(B) Keep the car loan. Instead, invest RM23,000 in a fund that generates 6% p.a.:

• Investment by the end of Year 2: RM25,842
  • Year 1: RM23,000 x 6% = RM1,380
  • Year 2: (RM23,000 + RM1380) x 6% = RM1,462.80
  • Total return: RM23,000 + RM1,380 + RM1,462.80 = RM25,842

• Total Gain: RM25,842 – RM23,000 = RM2,842

Since the gain from investing (RM2,842) > the cost of keeping the car loan (RM1,229), then using the money to invest is a more effective use of capital.

I hope this guide has been helpful!

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Disclaimer:

Not financial advice. Do your own due diligence before making any financial decisions.