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Home » What Is a Finance Charge on a Loan?

What Is a Finance Charge on a Loan?

Milena PetrovskabyMilena Petrovska
31.08.2020
Reading Time: 5min read
16
what is a finance charge on a loan

depositphotos / IgorVetushko

Banks, as we all know, make a profit by moving money from one place to another. They charge various fees for this service; in the case of loans, these can be called finance charges. Simply put, a finance charge is what borrowing money costs you.

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In other words, finance charges include any money you pay over and above what the cost would be if you dealt in cash. Interest is the most obvious example, but unlike interest rates, finance charges are expressed as a dollar amount and not a percentage.

Aside from making money – banking is a business. After all – the role of financing charges is to cover administrative costs. These vary depending on what kind of loans we’re discussing. A small personal loan may be quick to issue, while any bank will do a reasonably intensive background check before signing a mortgage. The finance charge on buying a house is, therefore, higher than that on a routine transaction.

Example: Car Loan Finance Charges

car loan finance charges
DepositPhotos by ginasanders

When you purchase a car with cash, or more likely a cash-like instrument like a check, things are pretty simple: you hand over an envelope and receive your keys and registration. With a car loan, finance charges get added to what you’ll end up paying.

If the dealership fills out the auto loan form for you, they will probably tack on an origination fee of between one and two percent. This fee is essentially the commission they earn for referring you to a lender, but it comes out of your pocket. The lender, for its part, charges you interest for the privilege of using their money and the risk they take by lending it to you.

Example: Credit Card Finance Charges

credit card finance charges
DepositPhotos by ginasanders

The first finance charge associated with credit cards is the merchant fee. Companies roll this charge into the sticker price, so you’ll probably not even be aware of it. On the other hand, this is why some retailers offer a small discount when paying with cash.

The finance charges you should begin to concern yourself with are with a balance transfer fee. When you switch credit cards, you typically move your outstanding amount from one company to another. You will probably pay a small percentage of the total to do this, but get a lower interest rate for the first couple of months you use the new card – sometimes, this interest rate is zero.

Once the introductory period expires, you’ll be subject to the typical APR or Annual Percentage Rate. This charge comes from a percentage that’s tacked on to your balance at the end of each month. In principle, it includes all routine fees. Credit card interest rates are typically very high compared to other types of loans, which is why it’s so important to pay them off quickly. If you owe $1,000 at the start of January, for instance, you may have to repay $1,017 in February. If you make no payments at all, that will have grown to $1,219 by the end of the year.

Another thing to be aware of is that cash advances on your credit card are treated differently from standard purchases. You’ll typically pay a higher APR on these as well as other charges.

Calculating (and Minimizing) Finance Charges

Working out how much you’re paying over the basic price when buying on credit can be a real eye-opener. Buying a car for $20,000 may look like a great deal, but paying it off over five years at 5% APR means it costs you $22,645, even without any other finance charges.

Your loan or credit card agreement should contain a section that spells out all of the loan costs. To calculate the finance charge, simply subtract the base price from the total you’ll have to pay. Online calculators can also come in handy for a finance charge calculation, especially for compound interest. Remember, though, that this assumes that you don’t make any late payments.

If this number seems too high, you can always try to negotiate with the lender – more often than not, they do have some room to maneuver on terms like the APR. If you still think you’ll be paying too much, you should look at other options, including waiting a while until your credit score has improved.

At the end of the day, however, borrowing money always costs money. The best way to reduce finance charges is really to borrow the smallest amount that will allow you to achieve your goals, for instance, by making a larger down payment on significant purchases.

The Devil in the Details and the Fiend in the Fine Print: Finding Finance Charges

Whenever you’re deciding on a lender, the first thing to do is make sure that you’re entirely clear about all the terms of your loan agreement. According to the Truth in Lending Act, each lender has to provide you with all relevant information in a clear and accessible form. They are still, however, more interested in your signature than your understanding, so spend as much time as you need to reviewing the contract, reading through their website, and asking questions.

Some of the terms can become a little confusing. Your credit card, for instance, probably has a grace period, meaning a number of days in the billing cycle you can go without paying for a new purchase before the interest clock starts ticking. This is why you need to persevere: unless you understand what you’re getting into, it’s probably a bad deal.

Milena Petrovska

Milena Petrovska

Content Manager
Milena holds a MA in Economic Sciences and has always been passionate about writing for the finance niche. She loves discovering new ways of improving personal wealth as much as she loves to share them with her readers. In her free time, Milena enjoys playing board games and going on road trips.

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Comments 16

  1. Mishel says:
    2 years ago

    I do not like loans because of the enormous fees and interest rates that I have to pay when taking loan. It turns out that you have to pay almost double the sum that you’ve borrowed. The banks charge fees on almost everything even on preparing documents.

    Reply
  2. Young says:
    2 years ago

    Banks survive and pay their employees on the interest rates and fees that they charge. Like every business, they offer services to the customers and they charge for their services. It is business like everything else. They also pay interest rates on deposits that citizens have in their bank. They charge use of credit cards and all the products they offer like in every other business. I really don’t understand why are people surprised when they see a fee charged from the bank, interest rate or cash withdrawal fee from a cash machine. And it is ok to go to dry cleaning service for example and nobody is surprised from the fee they are charging for the dry cleaning. It is somehow normal to pay for every service that we use, but banks, loan apps or similar services for loans then we are surprised of the fees they charge.

    Reply
  3. California says:
    2 years ago

    When you have to buy some thing that cost a lot of money, for example a car and you do not have enough money to buy it in cash it is normal to take some loan to do it. What you have to be careful of is what bank service you will chose and on what terms the loan will be which is a normal procedure. Try to find different services and to see all the terms that they offer. Some of them are charging higher fees than the others. Make sure that all the terms, interest rates and fees suit you. You will have also to check the period of the loan and the monthly payments to avoid burdening your income and to make sure that you will pay them on time. This way you will avoid late payments and additional charges that may occur. The banks have the obligation to display and reveal you all the terms of the contract that you are signing. So they have to answer on all the questions that clients might have.

    Reply
  4. Michael says:
    2 years ago

    You have to be in the bank business or at least a financial wizard to understand all the fees and the charges. For the most common people the main issue is how much they have to pay monthly and for how long. This is first that they see when they need a loan. Most of the people are not even aware of the fact that the additional charges apply with late payments and how the yearly percentage is calculated. If they see for example 2% interest rate they do not know how to calculate it. Which is normal because we are not all into the finance business. My only advice is: if you do not understand whatever contract you are signing, just take a copy of the contract and take to someone who understands it and will explain you in the simple way what the fine prints mean. Simple as that!

    Reply
  5. Marinela says:
    2 years ago

    I don’t understand what the banks charge, I only know that I always somehow owe them money. And it makes me angry!!!!

    Reply
  6. Dexter says:
    2 years ago

    For credit cards they charge monthly fees, yearly fees whatever fees. And always fees. It looks like it is more save to keep the money under pillow or in a jar. This way they can not charge fees.

    Reply
  7. Tina says:
    2 years ago

    In this modern era of living when everything is digital and online, having a couple of credit cards and loans, are normal in order to cover all the living expenses. It is our choice to choose from the different services that are offered on the market. So get yourself researching and find the best.

    Reply
  8. Brandon says:
    2 years ago

    Like everything else loans are necessity of the modern-era living. In these unsecure times when you do not know when you will loose your job and stay out of income we have to deal with the charges and loans and credit cards and…

    Reply
  9. Bernard says:
    2 years ago

    When I needed a loan to make some down payments for my house it was a journey of its own. From bank to bank, checking all the possibilities, applying, needed documents from everywhere, it is a mess really. Finally after a month I managed to get a loan (I am still repaying it, it was a long-term loan). I will avoid banks from now on as much as I can.

    Reply
  10. Zoe says:
    2 years ago

    If you want to take a loan from a bank or some institution, first you have to know that there will be different charges and fees that you will have to pay. So you will have to check different options and to see what is available on the market and to see if you are eligible for a loan. Anyhow, you need to do detailed research over the internet or in person.

    Reply
  11. Bentley says:
    2 years ago

    You should always negotiate for the charges and fees. Everything is negotiable, even this.

    Reply
  12. Cecilia says:
    2 years ago

    To be quite honest I was never bothered with the fees and charges that I have to pay for a loan or credit card. But definitely I will pay attention in future.

    Reply
  13. Dede says:
    2 years ago

    Dealing with different banks and loan companies I found out that the fees and the interest rates they charge are very different. Some of them even have significant difference when borrowing the same amount of money which in a period of a year can be a couple of hundred dollars. So check what are you up to when signing a contract.

    Reply
  14. Alice says:
    2 years ago

    Enjoyed reading. Very nice article. Thank you.

    Reply
  15. Pingback: What is a Live Check, and what should I do with it?
  16. zortilo nrel says:
    2 years ago

    Very interesting points you have remarked, thanks for posting.

    Reply

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