DTI ends Rule of 78

Rules that often penalise consumers who settle loans early are to be scrapped through new proposals announced today by Consumer Minister Melanie Johnson.

Johnson will outline plans to change the &#39Rule of 78&#39 (Consumer Credit Act 1974) – a formula which lenders use to calculate how much consumers have to pay when they settle a loan early. Around 70% of all personal loans are settled early, with the trend increasing.

Consumer credit regulations permit lenders to use the Rule of 78 to work out approximately how much the borrower owes at the point when a loan is settled early. However, the rule tends to overestimate the outstanding loan balance so borrowers are required to pay more than they would if other more accurate ways of working out the balance are used.

The DTI estimates that replacing the Rule of 78 with a more accurate formula is likely to lead to average savings to consumers of around £50 per loan agreement. Consumers with higher value loans could save thousands of pounds.

The new rules will not apply to most credit cards and mortgage loans. The Consumer Credit Act also only regulates loans up to a £25,000 but under DTI plans this limit may increase substantially in 2004 and loans for higher amounts will be regulated.

Johnson says: “When I began the consumer credit review, one of the priorities wasto amend the early settlement regulations to give consumers a fairer deal. I know from my postbag that many consumers are shocked when they find out how much it will cost them to settle some credit agreements early. With modern technology which can do calculations easily, there is no reason at all why the consumer should continue to be at a disadvantage.

“The formula used by many lenders to determine how much is owed in settlement favours the lender as opposed to the consumer. This is particularly true for long term, high value loans. I am today launching a consultation on this issue to explore options for making the early settlement terms fair to both lenders and borrowers. I am also looking at ways in which information on early settlement can be provided to consumers in a clear and understandable way when they are thinking of taking out a loan.”

This change will benefit:

– many consumers who want to pay off a loan early

– a consumer who wants to pay off one loan early and switch to a better deal

– consumers who default on loans and the trader effectively demands early settlement.

The courts use the early settlement rules to work out how much consumers owe when lenders take them to court for defaulting on a loan.

Today&#39s consultation coincides with the anniversary of the launch of the government&#39s review of consumer credit laws.

A progress report outlining work over the past year is published today. It outlines the work undertaken to bring the consumer credit laws up to date and more appropriate for today&#39s modern credit market and tackle the growing problem of overindebtedness.

Johnson adds: “We have already made good progress. Our review of the legal framework governing consumer credit, which has been in place for 30 years, is ambitious and wide-ranging and will deliver real benefits for consumers. The report sets out key areas of work for the next year, including plans to clamp down on rogue traders and tackle extortionate credit agreements head-on. I am considering many proposals as part of the review, including, for example, an independent consumer redress mechanism to deal with complaints about unfair lending practices.”