Finance Charge
Definition
A finance charge refers to any fee representing the cost of credit or the cost of borrowing. This can include interest payments, service fees, transaction fees, and other small costs associated with borrowing funds. Finance charges are often expressed as an annual percentage rate (APR) to enable easy comparison between various credit offers.
Example
Consider a scenario where a customer makes purchases of $400 on credit. Payment is made one month later. Based on an annual percentage rate (APR) of 18%, a finance charge of $6 is added to the bill. The calculation method can vary; here, we assume monthly compounding for simplicity.
Calculation formula based on monthly compounding: \[ \text{Monthly Interest Rate} = \frac{18%}{12} = 1.5% \] \[ \text{Finance Charge} = 400 \times 1.5% = $6 \]
Frequently Asked Questions (FAQs)
Q: What is an annual percentage rate (APR)?
A: The annual percentage rate (APR) is a measure of the cost of credit expressed as a yearly interest rate. It includes fees and charges (such as finance charges) and provides an overall picture of what a borrower can expect to pay annually for a loan or borrowing activity.
Q: How can I avoid finance charges on my credit card?
A: To avoid finance charges on your credit card, aim to pay off your entire balance by the due date each billing cycle. By doing so, you generally won’t incur interest charges on purchases.
Q: Are finance charges the same as late fees?
A: No, finance charges pertain to the cost of borrowing and regularly accruable interest or related fees. Late fees, on the other hand, are penalties assessed when a payment is made past its due date.
Q: How do finance charges affect my debt repayment?
A: Finance charges increase the total amount of debt you owe, making it potentially more expensive and lengthy to pay off the balance. Understanding and managing these charges can help reduce overall borrowing costs.
Q: Can finance charges apply to installment loans?
A: Yes, finance charges can apply to any type of credit or loan, including installment loans. They reflect the cost of borrowing generally through interest, but may also include additional fees or service charges.
Related Terms with Definitions
- Annual Percentage Rate (APR): The annual rate charged for borrowing, expressed as a percentage that represents the actual yearly cost of funds over the term of a loan.
- Interest Rate: The proportion of a loan charged as interest to the borrower, typically expressed as an annual percentage of the loan amount.
- Credit: An agreement wherein a borrower receives something of value now and agrees to repay the lender at a later date with potential interest.
- Debt: Money that is owed or due to another party, which can accrue additional charges or interest over time.
- Principal: The initial amount of money borrowed or the amount still owed on a loan, separate from interest or finance charges.
Online Resources
- Consumer Financial Protection Bureau (CFPB)
- Federal Trade Commission (FTC) - Credit & Loans
- Investopedia Articles on Credit and Finance
References
- “Understanding Credit Card Interest and Charges,” Investopedia.
- “Annual Percentage Rate (APR),” Consumer Financial Protection Bureau.
- “Credit Card Rates and Fees,” Federal Trade Commission.
Suggested Books for Further Studies
- “Your Score: An Insider’s Secrets to Understanding, Controlling, and Protecting Your Credit Score” by Anthony Davenport.
- “The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness” by Dave Ramsey.
- “Credit Repair Kit For Dummies” by Steve Bucci.
