What Is a Finance Charge?
A finance charge is a fee charged for the use of credit or the extension of existing credit. It may be a flat fee or a percentage of borrowings, with percentage-based finance charges being the most common. A finance charge is often an aggregated cost, including the cost of carrying the debt along with any related transaction fees, account maintenance fees, or late fees charged by the lender.
Understanding Finance Charges
Finance charges allow lenders to make a profit on the use of their money. Finance charges for commoditized credit services, such as car loans, mortgages, and credit cards, have known ranges and depend on the creditworthinessof the person looking to borrow. Regulations exist in many countries that limit the maximum finance charge assessed on a given type of credit, but many of the limits still allow for predatory lending practices, where finance charges can amount to 25% or more annually.
Finance charges are a form of compensation to the lender for providing the funds, or extending credit, to a borrower. These charges can include one-time fees, such as an origination fee on a loan, or interest payments, which can amortizeon a monthly or daily basis. Finance charges can vary from product to product or lender to lender.
There is no single formula for the determination of what interest rate to charge. A customer may qualify for two similar products from two different lenders that come with two different sets of finance charges.
Key Takeaways
- A finance charge, such as an interest rate, is assessed for the use of credit or the extension of existing credit.
- Finance charges compensate the lender for providing the funds or extending credit.
- The Truth in Lending Act requires lenders to disclose all interest rates, standard fees, and penalty fees to consumers.
Finance Charges and Interest Rates
One of the more common finance charges is the interest rate. This allows the lender to make a profit, expressed as a percentage, based on the current amount that has been provided to the borrower. Interest rates can vary depending on the type of financing acquired and the borrower's creditworthiness. Secured financing, which is most often backed by an asset such as a home or vehicle, often carries lower interest rates than unsecured financings, such as a credit card. This is most often due to the lower risk associated with a loan backed by an asset.
For credit cards, all finance charges are expressed in the currency from which the card is based, including those that can be used internationally, allowing the borrower to complete a transaction in a foreign currency.
Finance Charges and Regulation
Finance charges are subject to government regulation. The federal Truth in Lending Act requires that all interest rates, standard fees, and penalty fees must be disclosed to the consumer. Additionally, the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009 required a minimum 21-day grace period before interest charges can be assessed on new purchases.
FAQs
A finance charge is the total amount of money a consumer pays for borrowing money. This can include credit on a car loan, a credit card, or a mortgage. Common finance charges include interest rates, origination fees, service fees, late fees, and so on.
What is the legal definition of a finance charge? ›
The finance charge is the cost of consumer credit as a dollar amount. It includes any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit.
What is a finance charge for dummies? ›
Understanding Finance Charges
Finance charges are a form of compensation to the lender for providing the funds, or extending credit, to a borrower. These charges can include one-time fees, such as an origination fee on a loan, or interest payments, which can amortize on a monthly or daily basis.
What is a finance charge quizlet? ›
The finance charge is the cost of credit in dollars. It is calculated on a credit card's unpaid balance. A finance charge, the cost of having the debt a longer time, is added to the outstanding credit card balance.
What is always a finance charge? ›
A finance charge is the total amount of interest and loan charges you would pay over the entire life of the mortgage loan. This assumes that you keep the loan through the full term until it matures (when the last payment needs to be paid) and includes all pre-paid loan charges.
What is a finance charge also known as? ›
The most common formula is based on the average daily balance, in which daily outstanding balances are added together and then divided by the number of days in the month. In financial accounting, interest is defined as any charge or cost of borrowing money. Interest is a synonym for finance charge.
What is another word for finance charge? ›
Synonyms for finance charges in English
- financial expense.
- interest expense.
- interest charges.
- financial outlays.
- financial expenditure.
- finance expenses.
- financing cost.
- financial charge.
The average daily balance method adds up each day's balance, and then divides that total by the number of days in the billing cycle to get an average. That number is then multiplied by 1/12 of your APR, or annual percentage rate (this number can be found in your card's terms). The result is your monthly finance charge.
What is a simple finance charge contract? ›
Simple Interest Financing (SIF) is a common method of calculating finance charges, based on the agreed terms (amount financed, number of payments, interest rate/APR, due date, etc.) of a finance contract. Payments are allocated between accrued finance charges (interest) and principal.
How to figure finance charge? ›
To sum up, the finance charge formula is the following: Finance charge = Carried unpaid balance × Annual Percentage Rate (APR) / 365 × Number of Days in Billing Cycle .
A finance charge is part of the cost of borrowing money. Different types of debt can come with different types of finance charges. Understanding finance charges can help you pick the best borrowing option for you.
What is the difference between finance charge and interest? ›
According to accounting and finance terminology, the finance charge is the total fees that you pay to borrow the money in question. This means that the finance charge includes the interest and other fees that you pay in addition to paying back the loan.
What is the finance charge clause? ›
A FINANCE CHARGE will be imposed on all outstanding balances in your Account from the time they are posted to your Account; however, you can avoid FINANCE CHARGES on Purchases by paying the full amount of the New Balance of Purchases each month within 25 days of your statement closing date.
Which of the following is always a finance charge? ›
Interest is the most obvious example and most common finance charge. Other charges that always qualify include, but are not limited to: Loan origination fees. Mortgage broker fees.
What are finance charges expressed as? ›
It is usually expressed as an annual percentage rate (APR) and represents the cost of borrowing over a specific period.
What type of expense is a finance charge? ›
A finance charge refers to any type of cost that is incurred by borrowing money. Finance charges exist in the form of a percentage fee, such as annual interest, or as a flat fee, such as a transaction fee or account maintenance fee.
Why do I have a finance charge on my credit card? ›
With credit cards, your finance charge is the interest that has accrued on the money you owe during that particular billing cycle, plus any penalties, annual fees, transactions fees, and other fees.
What is a finance charge on a bill? ›
The most common type of finance charge is credit card interest, which is a percentage of what the amount you owe if you haven't repaid the minimum or the entire credit card bill. Finance charge will be charged on the ending balance amount on a daily basis from the transaction dat. Annual fee is usually fixed charge.
