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04/11/89 Lawrence Dechow Et Al., v. Sko-Fed Credit

April 11, 1989





536 N.E.2d 1382, 181 Ill. App. 3d 367, 130 Ill. Dec. 171 1989.IL.503

Appeal from the Circuit Court of Lake County; the Hon. Charles F. Scott, Judge, presiding.


JUSTICE REINHARD delivered the opinion of the court. NASH and DUNN, JJ., concur.


Plaintiffs, Lawrence and Judith Dechow, brought suit in the circuit court of Lake County against defendant, Sko-Fed Credit, a/k/a Skokie Federal Savings, alleging that a loan agreement with defendant provided for the collection of unlawful interest. Plaintiffs sought recovery pursuant to section 6 of "An Act in relation to the rate of interest and other charges in connection with sales on credit and the lending of money" (Interest Act) (Ill. Rev. Stat. 1985, ch. 17, par. 6413). Plaintiffs contend that a term in the agreement providing that upon prepayment of the loan, defendant would be entitled to collect an amount of interest based upon the "Rule of 78's" was in violation of the Interest Act, subjecting defendant to liability under section 6 of that act.

Plaintiffs and defendant filed cross-motions for summary judgment. The circuit court granted defendant's motion and denied plaintiffs'. Plaintiffs appeal the entry of summary judgment in favor of defendant and the denial of their own motion for summary judgment.

The only issue raised on appeal is whether defendant was entitled to calculate interest due upon prepayment by use of the Rule of 78's.

The pleadings and the affidavit of plaintiffs' attorney establish the following facts. On March 25, 1986, plaintiffs borrowed $49,000 for 15 years at a 15% rate of interest from defendant and executed a promissory note. The loan was secured by a first mortgage on plaintiffs' personal residence. The promissory note contained the following provision:

"REBATE FOR PREPAYMENT: Borrower(s) may prepay this note in full (by cash, renewal or refinancing, or a new loan) one month or more before the final installment due date and receive a statutory refund or credit of the total of applicable interest for all fully unexpired installment periods as originally scheduled or as deferred which follow the day of prepayment. This statutory computation employs the 'sum of the digits' method, also known as the 'Rule of 78ths'. Prepayment in full will reduce both the Finance Charge and Insurance Charge for the loan."

In September 1987, plaintiffs were informed that the payoff balance on the loan was $54,634.60. Plaintiffs' attorney sent defendant a letter requesting that the payoff balance be computed based upon principal balance plus accrued interest which, he noted, would result in a payoff balance lower by approximately $6,000. Defendant responded that pursuant to the terms of the promissory note, the Rule of 78's was the proper method for determining the payoff balance. Plaintiffs then filed their complaint, and the circuit court entered summary judgment in favor of defendant, finding that the validity of the Rule of 78's was determined by the Illinois Supreme Court in Lanier v. Associates Finance, Inc. (1986), 114 Ill. 2d 1, 499 N.E.2d 440.

The Rule of 78's, also known as the "sum-of-the-digits" method, is a formula for computing an amount of interest due upon early payment of a loan. Under this method, a higher percentage of the total finance charge is attributable to the first months of a loan than is attributable to the last months. (Lanier, 114 Ill. 2d at 6, 499 N.E.2d at 442.) The operation of the rule is best illustrated with an example of a one-year loan payable in 12 monthly payments. First, a total finance charge is calculated based upon payment of the loan over its full term. Next, for this loan payable in 12 installments, the numbers 1 to 12 are added together, equaling 78. If the borrower repays the loan after the first month, he must pay 12/78 of the total finance charge. If the borrower repays after the second month, he must pay 12/78 for the first month plus 11/78 for the second month, and so on. Thus, if the borrower repays after the eleventh month, he will be responsible for 77/78 of the total finance charge. (See Lanier, 114 Ill. 2d at 6-7, 499 N.E.2d at 442.) Application of the Rule of 78's allows the lender to collect, upon prepayment, an amount greater than the total interest accrued on the principal balance prior to prepayment of the loan. See Lanier, 114 Ill. 2d at 7, 499 N.E.2d at 442.

Plaintiffs argue on appeal that the circuit court erred in finding that the Rule of 78's could properly be applied to their loan, which was for an amount greater than $25,000 and was secured by a mortgage on residential real estate. Defendant maintains that there is clear authority allowing application of the Rule of 78's in this situation.

We respond first to defendant's arguments in support of its right to apply the Rule of 78's to plaintiffs' loan. Defendant contends that in Lanier, the Illinois Supreme Court approved of this practice. In Lanier, the plaintiff borrowed $24,961.68 for 10 years, secured by a first mortgage on her home. The loan agreement provided for a refund of the unearned finance charge upon prepayment computed according to the Rule of 78's. The plaintiff instituted a class action claiming violations of the Consumer Fraud and Deceptive Business Practices Act (Consumer Fraud Act) (Ill. Rev. Stat. 1981, ch. 121 1/2, par. 261 et seq.). In Lanier, the court held that use of the Rule of 78's does not constitute a penalty requiring disclosure under the Federal Truth in Lending Act and further concluded that compliance with the Truth in Lending Act is a defense to liability under the Consumer Fraud Act. (114 Ill. 2d at 16-18, 499 N.E.2d at 446-47.) Thus, Lanier merely addresses the applicability of the Consumer Fraud Act ...

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