What is a Finance Charge?

The finance charge is the expense incurred on borrowing money. In simple words, it is any sum a borrower must pay in addition to the amount borrowed. The most common example is the amount of interest charged on loan. It can be in the form of a percentage charge, like yearly interest, or a Flat price, such as a transaction fee or account maintenance fee and any additional borrowing expenses, such as late fees.

Finance charges vary depending on the sort of loan or credit you have and the firm you are borrowing from. Home loans come with additional financing costs. A mortgage entails paying interest, discount points, mortgage insurance and other expenses. In short, anything above the loan’s principal amount is a finance charge.

Finance Charge on Loan

A finance charge on a loan is the cost of a loan that needs to be paid throughout the life of the mortgage loan, including principal and interest. If you retain the loan until it matures, all prepaid loan costs will be included. Included in the loan fees are:

• Origination fees
• Discount points
• Mortgage insurance
• Other lender fees

Finance Charge Calculator

Holding a credit card with a balance brings up the cost of borrowing the amount. You'll be charged interest in the form of a finance charge. To calculate finance charges levied, you need to know three details about your credit card balance: the credit card (or loan) amount, the Annual Percentage Rate (APR), and the Billing cycle duration.

The mathematical equation for finance charge formula is as follow:

Monthly finance charge = Credit card balance x Monthly rate

The monthly rate can be calculated by dividing APR by the number of billing cycles in a year.

Finance Charge Example

Let’s take an example; you are a holder of a credit card whose billing cycle lasts a month. The credit card balance is 10000 INR, and APR is 15%. What would be your finance charge for the above?

To calculate the finance charge, firstly, you need to convert APR into a monthly rate. Since the billing cycle lasts a month, it can be ascertained that there are 12 billing cycles in the year.

Monthly rate = 15% / 12

= 0.15/12 = 0.0125 or 1.25%

Monthly finance charge = Credit card balance x Monthly rate

= 10000x 0.0125 = 125 INR

Finance Charge vs Interest

Learning about the difference between a finance charge and interest rate can be a challenge. But knowing the difference is crucial if you want to save money and find the appropriate product.

When you get a loan from a Bank, you usually borrow a fixed sum called the principal. It needs to be repaid, but because the lender is taking a risk by supplying this money, they will impose an interest rate that is a percentage higher than the principal.

In other words, the lender earns profit as a percentage based on the amount borrowed for a time period. Interest rates depend on the creditworthiness of the borrower and the type of financing. For instance, secured financing such as a Home Loan, vehicle loan, which is often backed by an asset, is available at lower interest rates, whereas unsecured financing, like credit cards, is available at higher interest rates.

Finance charges is a wider concept than that of interest rate. It is a fee charged for the use of credit. The Annual Percentage Rate (APR) is the rate at which a financial institution charges borrowers for borrowing money. While it does include the interest paid on credit, it also includes all additional costs that aren't included in this one variable. This might include costs for establishing credit, fees for servicing the loan, or even a charge for paying off the loan early. This all contributes to financing charges.

It can be concluded that the finance charge is a predetermined amount of money that you are charged for being provided with a loan in personal financial concerns, such as a payday loan or buying a used automobile on credit. Depending on the lender, you may be charged this fee regardless of whether you pay off the loan early or not. When you pay an interest rate, on the other hand, you will pay less to borrow money if you pay it off soon.