What Is a Finance Charge?
A finance charge is the total cost of borrowing money, including interest, fees, and other costs associated with credit. It applies to:
Credit card balances
Loans (personal, auto, mortgage)
Installment payments
Late invoice payments
Finance charges help lenders compensate for risk and cover administrative costs.
How Finance
Charges Work?
| Component | Description | Example |
|---|---|---|
| Interest | Percentage of principal | 15% APR on credit card |
| Fees | Flat or periodic charges | $25 late fee |
| Service Charges | Account maintenance | $10 monthly fee |
Common Calculation Methods
Daily Balance
Interest calculated on each day’s balance
Common for credit cards
Average Daily Balance
Uses monthly average balance
Often for revolving credit
Adjusted Balance
Subtracts payments before calculating
Most favorable to borrowers
Types of Finance Charges
1. Credit Card Finance Charges
Purchase APR: Interest on unpaid balances
Cash Advance Fee: 3-5% of withdrawn amount
Balance Transfer Fee: 3-5% of transferred sum
2. Loan Finance Charges
Origination Fees: 1-6% of loan amount
Prepayment Penalties: Fees for early payoff
3. Invoice Finance Charges
Late Fees: 1.5-5% of overdue amount
Interest on Overdue Invoices: Typically 1-2% monthly
How to Calculate Finance Charges
1. Credit Card Finance
- Outstanding Balance: $2,500
- APR: 22%
- Billing Cycle: 30 days
22% ÷ 365 = 0.0603% (0.000603 in decimal)Step 2: Calculate Daily Charge
2,500 × 0.000603 = 1.51Step 3: Determine Monthly Charge
1.51 × 30 = $45.30 finance charge
2. Invoice Late Payment
- 1.5% monthly interest (18% APR)
- 5% late fee
3,000 × 1.5% = 45Late Fee:
3,000 × 5% = 150Total Finance Charge:
45 + 150 = $195 finance charge
3. Loan Finance
- 8% interest rate
- 2% origination fee
- 12-month term
10,000 × 8% = 800Origination Fee:
10,000 × 2% = 200Total Finance Charge:
800 + 200 = $1,000 finance charge
Finance Charge vs. Interest Rate
| Factor | Finance Charge | Interest Rate |
|---|---|---|
| What It Includes | All borrowing costs | Only interest percentage |
| Disclosure | Shown as dollar amount | Expressed as APR |
| Purpose | Shows true cost of credit | Measures annual interest |
FAQs
Sometimes—especially for:
- Mortgages
- Auto loans
- Business credit lines
Pay credit card balances in full each month
Negotiate grace periods with vendors
Set up automatic payments
- Businesses: Yes, as interest expense
- Individuals: Only for mortgage/student loans
Varies by:
State laws (usury limits)
Loan type (payday loans capped at 36% APR federally)
