What Is a Finance Charge?
A finance charge is a fee imposed for the use of credit or the extension of existing credit. It can be a flat fee or a percentage of borrowings, with percentage-based finance charges being more common. Often, a finance charge is an aggregated cost, including the expense of carrying debt along with any associated transaction fees, account maintenance fees, or late fees charged by the lender.
Understanding Finance Charges
Finance charges enable lenders to profit from lending their money. For common credit services like car loans, mortgages, and credit cards, finance charges depend on the borrower’s creditworthiness and have defined ranges. Regulatory limits exist in many countries to cap maximum finance charges for certain credit types. However, some ceilings still allow for predatory lending practices, where annual finance charges can exceed 25%.
Finance charges serve as compensation to the lender for offering funds or extending credit to a borrower. These charges can include one-time fees, such as a loan’s origination fee, or interest payments, which may amortize monthly or daily. Finance charge rates can vary widely between products and lenders.
There isn’t a universal formula to determine the interest rate. A borrower might qualify for similar products from different lenders, each with a unique set of finance charges.
Key Takeaways
- A finance charge is assessed for the use of credit or extension of existing credit.
- These charges reimburse lenders for providing funds or credit.
- The Truth in Lending Act mandates that lenders disclose every interest rate, standard fee, and penalty fee to consumers.
Finance Charges and Interest Rates
One of the most typical finance charges is the interest rate. This allows the lender to make a profit, expressed as a percentage of the current amount provided to the borrower. Interest rates can fluctuate based on the type of financing and the borrower’s creditworthiness. Secured loans, backed by an asset like a home or vehicle, often have lower interest rates compared to unsecured loans like credit cards due to the reduced risk.
For credit cards, all finance charges are presented in the issuing card’s currency, facilitating transactions in foreign currency.
Finance Charges and Regulation
Government regulations oversee finance charges. The federal Truth in Lending Act requires the disclosure of all interest rates, standard fees, and penalties to consumers. The Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009 notably enforces a minimum 21-day grace period before interest on new purchases can be applied.
Related Terms: interest rate, creditworthiness, predatory lending, origination fee, amortization.
References
- Office of the Comptroller of the Currency. “Truth in Lending”.
- Federal Trade Commission. “Public Law 111–24—May 22, 2009, Credit Card Accountability Responsibility and Disclosure Act of 2009”, Page 10.
