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The rule of 78

Gordon, the sole managing director of a company, purchased a vehicle in the name of the company, and answered ‘yes’ to the following question on the loan application: “Do you intend to use the motor vehicle mainly (more than 50%) for business or investment purposes?”. The loan was structured over a three-year period, but after two years Gordon decided to sell the vehicle.

Gordon contacted the lender and asked if he could repay the loan early. The lender said that he could, and that would cost Gordon $42,000, including an early repayment cost. When Gordon did his own calculation, he calculated the repayment, including the early repayment cost, should cost $39,000.

When Gordon asked the lender about the discrepancy, it explained the calculation, referring to the rule of 78. Gordon disputed the lender’s ability to calculate the early repayment cost using the rule of 78, and said it was obliged to follow the formula prescribed by the Credit Contracts and Consumer Finance Act 2003 (the Act). When the lender did not agree, Gordon referred the complaint to FSCL.



Gordon said that the rule of 78 was not a fair calculation and that, because he had not completed a declaration of purpose, as allowed by section 14 of the Act, the contract must be treated as a consumer credit contract obliging the lender to use the formula prescribed by the Act.

The lender did not agree, saying the lending was not a consumer credit loan and that the loan agreement stated that, unless the loan was a consumer credit loan, the early repayment cost would be calculated using the rule of 78.



The rule of 78 was used in pre-computer times as a quick and easy, but somewhat inaccurate way of calculating interest when a lump sum was paid off a loan. The formula was used in the Hire Purchase Act 1971 before it was repealed when the Act came into force. While the rule of 78 has fallen out of favour with respect to consumer credit loans, when Parliament revised its enacted the Act in 2003 it was not prohibited entirely. Instead Parliament drew a distinction between commercial and consumer lending, allowing early repayment costs in a commercial context to be determined by the contractual agreement between the parties.

We considered there was no doubt that the loan was a commercial loan. Section 11 of the Act states that to be a consumer credit loan the lending must be to a natural person and that the lending must be wholly or predominantly for personal, domestic or household purposes. Not only was the lending to a company, but Gordon had indicated that he intended using the vehicle mainly for business purposes.

While section 14 allows the parties to clarify the purpose of the lending as commercial, and many lenders may well ask borrowers for a declaration of the purpose of the lending, section 14 does not override the fundamental requirement in section 11 that a contract can only be a consumer credit contract if the lending is to a natural person.



Gordon did not accept our provisional view and continued to submit that the contact should be considered a consumer credit contract. We did not agree and issued a recommendation that Gordon discontinue his complaint.


Insights for consumers and participants

The calculation of early repayment costs is one example of the additional protection provided to consumers by the Act. While section 14 allows the parties to clarify that they are not entering a consumer credit contract but a commercial contract, it does not replace section 11 when determining what will be considered a consumer credit contract.