Finance Charge Definition: Everything You Need to Know
The finance charge definition is the fee required to receive a credit or an extension of credit on an existing account.3 min read
What Is a Finance Charge?
The finance charge definition is the fee required to receive a credit or an extension of credit on an existing account. The fee may be charged in the form of a flat fee, or most commonly, as a percentage of the amount of money that is owed or borrowed.
In most cases, the finance charge is an aggregated cost, which means it includes all of the costs that are carried along with the debt, such as account maintenance fees, transaction fees, and late fees. There may also be some differences in the way the finance charge is set up, depending on the type of account or the type of creditor.
Some industries or loan types have common finance charge ranges that depend on the ranking of the borrower's credit score. In some countries, there are even regulations set for the maximum amount a finance charge can be set for.
The Truth-in-Lending Act was implemented to hold finance lenders accountable for the full disclosure of all finance charges. The point of the Truth-in-Lending Act is to disclose important information about the accounts and fees to the consumer. However, it does not provide any restrictions on how the finance charges are calculated. The main requirements for the Truth-in-Lending Act include that the creditor must:
- Disclose the annual cost of the consumer's credit.
- Provide key information about the consumer's credit transactions.
- Set procedures for correcting any billing mistakes.
Why Do I Have a Finance Charge?
Finance charges may be assessed for a variety of reasons. A few of these reasons include:
- Interest expense
- Loan origination fee
- Balance transfer fee
- Late payment fee
- Transaction fee
- Foreign transaction fee
- Account maintenance fee
How Is a Finance Charge Calculated?
The calculation of a finance charge will differ based on the type of finance charge, account, and how the lender calculates. In many cases, the finance charge is applied to the balance that is owed.
The annual percentage rate, also known as APR, is commonly used when calculating finance charges. Many credit accounts use a method that multiplies the average daily balance of the account by the APR and the number of days in the billing cycle.
For example: Average Daily Balance x APR x # Days in Billing Cycle
One way to avoid or decrease the amount of the charge is to pay off the account or pay down the account before the end of the statement period or billing cycle.
When Are Finance Charges Assessed?
When purchasing on a credit account or acquiring a loan, interest and finance charges are assessed for a few reasons: if the account has any interest rate percentage above 0 percent, if the account balance at the beginning of the billing cycle was higher than zero, and if no grace period for payment has been provided. In some cases, a finance charge may be assessed in error. If this happens, the consumer should contact the creditor immediately so that they can investigate.
Locating Your Finance Charges
Account statements can be set up in various ways, depending on the creditor. Typically, there is a summary of the account on the first page. The total finance charge should be listed in this section and a may also be referred to as an interest charge. Within the statement details, there is often a section detailing the transactions and finance charges associated with the account. The section will usually break down the charges by date and reason.
How to Reduce Finance Charges
It will be difficult to pay off an account if only the minimum payment is made each month. The payment is usually enough to cover the interest accruing on the account, but not much else. One way to reduce the amount of interest owed on an account is to pay off the balance faster. This means making payments larger than the monthly minimum, making extra payments throughout the month, or transferring the balance to a lower-interest account.
To completely eliminate the interest fees, the account will need to be paid off or transferred to an account that provides a 0 percent interest as a new account perk. This will reduce the interest if the account is then paid off before the entry rate ends.
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