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What is a Finance Charge?

By
Andrew Tavin
Andrew Tavin covers budgeting and credit scores for OppLoans. His experience as a comedian lends an approachable and humorous angle to his content and makes the scary parts of personal finance less intimidating for readers.
Updated on May 24, 2021
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They say nothing in life is free. That includes borrowing money.

They say if you want a free loan, find a secret rich uncle you never knew about before. 

Maybe people don’t actually say that, but they should start. Because almost any loan you take out, unless it’s from an understanding friend or family member, is going to cost you some form of payment. 

If you find yourself borrowing from a more formal resource — like a bank or other type of lender — the cost is likely to originate in the form of a finance charge.

What is a finance charge?

A finance charge is a general description of a cost associated with a loan. 

A finance charge is essentially any amount you have to pay the lender beyond the amount you borrow  (the amount you borrow is also referred to as the principal). These additional costs are charged by the lender, both for profit and to cover the cost of processing the loan. Some loans might allow you to avoid a finance charge, while others will not be so flexible. 

Finance charges may also include interest charges, though some lenders may separate interest from other costs of borrowing.

Types of finance charges

There are many types of loans —  which means there are many types of finance charges. 

Not all loans are structured the same, so it can be difficult for a borrower to compare loans from different lenders. That’s why the Truth In Lending Act requires lenders to express loan costs in the form of an APR — or annual percentage rate. 

APR is a number that shows the total amount of finance charges — whether they show up as interest or an upfront cost — and is presented as a percent of the amount that was borrowed. Although it isn’t always a perfect measure, it can better allow you to compare different loans to figure out the most affordable way of borrowing money.

Since there are many types of loans, it doesn’t make sense to only talk about finance charges in the abstract. Instead, let’s look at some different kinds of loans and the finance charges associated with them. 

Credit card finance charges

Wait, credit cards are loans? Technically, yes.

A credit card is a revolving line of credit, which is a type of loan that allows you to borrow a certain amount of money under a given limit. If you want to borrow more money, you have to pay back a portion of the money you’ve already borrowed.

While some credit cards charge an annual fee, others allow you to avoid finance charges entirely. That’s because most credit cards come with a grace period on new transactions of about a month before they start to charge for interest on purchases. As long as you pay off your entire credit card balance before the due date each billing cycle, you won’t have to worry about finance charges.

On the other hand, if you only make the minimum payment due on your balance each month – the least amount of money you have to pay on your bill each month, regardless of whether you pay it off in full — interest will accumulate on the remaining balance. If you never pay off your balance entirely, you could find your monthly payment rising as the amount of interest you owe — and the amount of money you owe, overall — grows. Additionally, if you make a late payment, you may face late fees.

Once you start to rack up credit card debt, it can be difficult to turn your situation around as your credit card bill continues to grow. If you find yourself in this situation, consider a repayment plan that prioritizes your credit cards. 

Credit card offers

Some credit card companies have special limited-time 0% APR offers. If you qualify for one of these cards, performing a balance transfer from a credit card with a higher interest rate to the new credit card with no interest rate could aid in paying off the old debt. However, there are some considerations to keep in mind:

  • Can you pay off the new card before the offer ends? If so, you might be able to get out from under your old finance charges. However, if you can’t pay off the balance in time, you may find yourself taking on additional costs.
  • Is there a fee to transfer over a balance from a different card? Some credit card companies charge a balance transfer fee, which can be a percentage of the amount you are moving to the new card.

With this in mind, be sure to do your research so you don’t end up in a more expensive situation with a different credit card issuer. Of course, the best plan of action is to never carry over a balance on any credit card from month to month. Paying off your balance in full each month will also reflect well on your credit score. 

Payday loans

Payday loans are short-term, high-APR loans that must be paid back in a certain number of days. Unlike many other loans, the cost of borrowing does not necessarily come in the form of interest rates, but is instead a flat fee. If the borrower cannot pay the loan back in time, then they must extend it or roll it over (in addition to paying the finance charge again). 

If a borrower cannot pay the loan after one extension, the cycle will repeat until the borrower pays off the full dollar amount. 

Payday lenders are often considered riskier than other financial institutions and are often used by borrowers who need a personal loan but can’t qualify for traditional consumer credit or financial services.

Cash advance loans

Technically, a cash advance is a loan taken out by using a credit card at an ATM. In addition to whatever transaction fees the ATM may carry, cash advances tend to have higher interest rates than regular credit card transactions, and they don’t come with a grace period.

Many payday lenders will also refer to their product as a “cash advance.” If you’re considering a cash advance that you don’t acquire by using your credit card at an ATM, then that is probably a payday loan and will come with a similar finance charge structure as one. 

Installment loans

Generally, an installment loan is a personal loan that a borrower pays off in installments over a longer period of time. Ideally, installment loans are amortized, which means that each payment covers a portion of the interest and other finance charges as well as the principal, so the entire loan can be paid off in a predetermined amount of time.

There are personal installment loans for general purposes as well as more specific installment loans, such as mortgages, auto loans, and student loans. Each of these loan types comes with its own form of finance charges. Mortgages, for example, tend to have origination fees, discount points, insurance requirements, and more. In fact, mortgages are one of the more complex types of loans, deserving of an entire article [link to mortgage article once published] of their own.

To finance or not to finance

While it often isn’t possible to avoid finance charges entirely, your personal finances could be improved if you find ways to minimize them. You can’t always avoid borrowing money, but you can do your best to pay less to do so.

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