Finance Charge

Finance Charge Definition

Finance Charge can be termed as a cost of borrowing or cost of credit and is the accrued interest or the fees which have been charged on the approved credit facility; at times there is a flat fee for the charge, however, most of the time it is percentage of the borrowing of extended line of credit.

Explanation

Finance-Charge

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For eg:
Source: Finance Charge (wallstreetmojo.com)

Types

  • In a broader sense, there are really two types of Finance charges, one is the percentage of the amount borrowed i.e. the interest and the other one is the fixed fees being paid during or before the transaction i.e. The fees.
  • Most of the charges fall under this category and these charges have to be borne by the end consumer or borrower as per the set guidelines by the regulatory authorities.

Finance Charge Formula

There is no one rule to follow when we do the calculation of the finance charge since most of the transaction differs from one another the charge is calculated accordingly.

Let us look at one the simple and widely used formula which is a percentage of the amount borrowed.

Finance Charge Formula = (outstanding amount * interest rate * no of days) / 365

How to Calculate Finance Charge?

Suppose we have a bill of $350 for the month of December 2019 and the last payable date for the same is 6th January 2020. So, the charge is levied upon after 6th January 2020 on a daily basis till the time one does not clear the dues.

Let us assume that we do not pay this bill till 6th January and instead we pay it on 16 January 2020, so here the charges for 10 days will be applied to us at 20% interest rate.

Calculation of the finance charges for 10 days will be, (350 * 0.20 * 10) / 365 = $ 1.92, so the borrower will have to pay the final amount of $350 + $1.92 = $351.92.

Example of a Finance Charge

Let us take an example of Mr Smith who has a mortgage loan $2000 and his monthly EMI is $100 for 20 months which includes 15% interest per annum.

Smith is very regular in his payments every month except for one month where he miscalculated and couldn’t pay his EMI on time. He paid the EMI on 30th of that month which means that he was late by 30 days.

So, here the finance charges will be applied for 30 days, (2000*0.15*30)/365 = $24.66, Mr Smith will not only have to pay $24.66 interest on the missed EMI deadline but will also have to bear other financial charges of $20 for the late payment. Furthermore, it will also dent his credibility image as a borrower which will be accounted for in his credit score.

Purpose

Conclusion

The finance charge is a kind of gain for the lender and an expense for the borrower, but the cost is worth since the borrower will have liquidity at his disposal just by paying a certain amount. Though there are mostly limited charges to be imposed, however, there is always an upper limit on the interest rate set by the regulators which will avoid market exploitation.

Recommended Articles

This has been a guide to Finance Charge and its definition. Here we discuss how to calculate finance charge along with its formula, example, types and purpose. You can learn more from the following articles –