You may have recently come across the phrase 'Rule of 78' and you must be wondering what the big fuss is all about! Well, if you are a hire-purchase consumer or intending to be one or are someone who heavily relies on hire purchase (HP) to improve your living standard, than this issue does concern you.
'Rule of 78' is a formula used in hire-purchase industry to calculate rebate, settlement or redemption figure for a loan that you must pay to settle the loan.
But have you ever thought about how your settlement figure is determined when you buy goods on hire-purchase? The truth is that consumers are not interested to go the extra mile and find that out even though it is your right. Consumers instead put all their trust in the hire-purchase company thinking they are right and know better.
Do you know HP companies use double standards when it comes to the calculation of interest when a loan is taken and providing rebate for early settlement of your credit purchase? Compound interest is applied when loan is taken while the rebate is calculated on the reducing balance. This practice is unfair to consumers. Why?
By using Rule of 78, the hire-purchase company collects bulk of the loan's interest in the earlier periods of the loan term. It unfairly penalises you if you pay the debt any earlier than the expiry of the full term of the credit contract. The earlier the debt is paid, the heavier the penalty is imposed on the early payments which benefit the hire-purchase company generously.
The Consumer Council of Fiji's report on Hire Purchase Industry came out strongly against the application of 'Rule of 78' in this sector because it is grossly unfair on consumers who end up paying more to hire-purchase companies. Hence, consumers fall victim to 'Rule of 78' and continue to lose substantial amount of their money.
The following are the reasons why the council would like to see 'Rule of 78' abolished.
* Complex and confusing formula - First and foremost 'Rule of 78' is a complex and confusing formula beyond the understanding of an average consumer. While the credit providers will have no problem calculating the rebate by using the 'Rule of 78', most consumers on the other hand will be unable to check whether the rebate amount is correct because of its complexity.
* Hidden charge paid - The difference between the cost of early repayment calculated according to a daily rate or actuarial basis, and the amount calculated according to the Rule of 78 becomes, effectively, a hidden charge paid by the consumers to the hire-purchase companies. This charge does not relate to any particular cost, and so it can be regarded as the hire purchase companies' unearned interest. The consumer may not even notice the charge because it is hidden as part of the overall rebate calculation.
* Lack of transparency - The lack of transparency means that the consumer cannot evaluate the impact of early payment of his/her loan at the starts of the loan. Hire-purchase contracts are not required to disclose early repayment charges, and unfortunately most contracts do not draw to the consumer's attention the consequences of early repayment.
* Open to abuse - Use of the 'Rule of 78' can be abused and lead to further consumer detriment. If a loan is frequently refinanced, and the outstanding balance calculated using the rule, the hire- purchase companies are constantly recovering unearned interest. The rule is widely recognised to be inequitable, as the hirer effectively pays an additional amount to the hire -purchase companies.
* Inconsistent with the general rule in the law - The 'Rule of 78' is clearly inconsistent with the general rule in the law where the quicker you pay the balance the lesser interest you pay. Unfortunately, application of 'Rule of 78' results in very significant advantage to the hire purchase companies and a very significant disadvantage to the consumers. The credit provider gets much more interest if the consumer pays early.
* And sadly, by the 'Rule of 78', the Act allows credit providers to legally exploit consumers.
Rule of 78 in other
countries' legislation
Most countries with similar consumer credit law to Fiji have abolished or restricted the Rule of 78, or at least are considering doing so. Lenders in Canada, UK, Australia, New Zealand can no longer use the rule to calculate the outstanding balance on a loan. The US Congress for instance has outlawed the use of the 'Rule of 78' formula in more than 15 states while other states are proposing for it to be removed. Also 'Rule of 78' has been abolished in Ireland, Wales and Scotland. Consumer credit reform has been tagged as a priority for consumer law reform in some Asian and African countries because in many respect the existing consumer credit law is outmoded and behind equivalent statutes in many western countries.
In UK, Consumer Credit Act allows lenders to only charge 28 days interest for early settlement. In Australia and New Zealand, more equitable and transparent method is used for calculating early repayment rebates unlike the Rule of 78. It is the use of the "actuarial rule". The principle of the actuarial method is that the borrower's payment on ending the loan early should result in them paying finance charges at the same rate over the shortened term as they would have done over the full term of the loan.
Abolishing 'Rule of 78' will create a fair and balanced market between hire-purchase companies and consumers by ensuring costs are reasonable and transparent.
* Next week: We focus on home brand products and its quality.
* This is a weekly contribution from the Consumer Council of Fiji.