Definition of finance charges

What is a finance charge?

A finance charge is a costs billed for using credit or extending existing credit. This can be a flat fee or a percentage of borrowings, with percentage-based finance charges being the most common. A finance charge is often an aggregated cost, including the cost of debt as well as related transaction fees, account maintenance fees, or late fees charged by the lender.

Understanding Finance Charges

Finance charges allow lenders to make a profit on the use of their money. Financial costs for trivialized credit services, such as auto loans, mortgages, and credit cards, have known ranges and depend on the solvency of the person seeking to borrow. There are regulations in many countries that limit the maximum finance charge assessed on a given type of credit, but many of the limits still allow predatory loan practices, where financial charges can amount to 25% or more per year.

Finance charges are a form of compensation to the lender for providing funds or extending credit to a borrower. These charges may include one-time charges, such as a assembly costs on a loan, or interest payments, which may dampen on a monthly or daily basis. Finance charges may vary from product to product or from lender to lender.

There is no single formula for determining the interest rate to charge. A customer may qualify for two similar products from two different lenders that come with two different sets of finance charges.

Financial charges and interest rates

One of the most common finance charges is the interest rate. This allows the lender to make a profit, expressed as a percentage, based on the current amount that has been provided to the borrower. Interest rates may vary depending on the type of financing acquired and the creditworthiness of the borrower. Secured financing, which is most often backed by an asset like a home or vehicle, often has lower interest rates than unsecured financing, like a credit card. This is most often due to the lower risk associated with an asset-backed loan.

For credit cards, all finance charges are expressed in the currency from which the card is based, including those which can be used internationally, allowing the borrower to carry out a transaction in a foreign currency .

Financial charges and regulations

Finance charges are subject to government regulations. The federal Truth in Lending Act requires that all interest rates, standard fees and penalties be disclosed to the consumer.Additionally, the Credit Card Accountability and Disclosure Act of 2009 (CARD) required a minimum grace period of 21 days before interest charges can be assessed on new purchases.