Whether taking out a loan or a line of credit, it accompanies a fair share of financial obligations. Understanding these commitments is crucial if you want to make sound decisions. One such obligation is the finance charge.
Finance charges are the cost of borrowing money. So, please read this article to learn more about finance charges, how they work, methods to calculate them, and ways to avoid them before signing any loan or credit contract.
What Is a Finance Charge?
A finance charge refers to the cost of the money you borrowed from a lender, credit card issuer, or any financial institution for borrowing on credit. For instance, if you have a credit card and fail to make the minimum payment within the grace period, the issuer can charge an additional fee for the late payment. It is one of the many examples of a finance charge.
A late-payment fee is not the only way you encounter a finance charge. It comes in various forms. Any amount you spend apart from the principal amount borrowed, whether a business loan, a mortgage, or a credit card, is considered a finance charge.
Any borrower who borrows funds or uses credit becomes liable to pay the associated finance charge. These charges reduce the risk for lenders. In a way, lenders receive compensation through finance charges for lending funds or extending credit to borrowers.
How Do Finance Charges Work?
Finance charges are usually included with each monthly billing cycle. Finance charges can vary depending on the terms and conditions of your loan or credit.
The Truth in Lending Act of 1968 mandates that lenders disclose the finance charges associated with a loan or credit to the borrower before signing an agreement. It outlines the information a borrower must know before consenting. The act requires the lender to:
- Disclose the annual cost of credit to a borrower
- Provide essential information regarding the credit transactions
- Frame procedures to correct any billing error
What Is Included in a Finance Charge?
There is no exact or definitive amount of a finance charge. It’s a broad term encompassing almost any direct or indirect charge a borrower pays. Some of the typical types of finance charges include:
- 1. Interest rates: A percentage of the amount borrowed that is charged by the lender for letting you use its money.
- 2. Transaction fees: An expense paid each time a customer performs a transaction.
- 4. Appraisal fees: You pay an appraiser to assess the value of a property you are looking to buy.
- 5. Origination fees: An upfront fee ranging from 0.5 to 1% that a lender charges for processing a loan.
- 6. Other finance charges could include:
- Loan fees
- Cash advances on credit card
- Credit Report fees
- Required insurance premiums
- Closing costs
- Prepayment penalties
- Annual Percentage Rates
What are Some Common Methods used to Calculate Finance Charges?
Financial institutions, banks, or companies lending money use finance charges to make a profit by lending loans and credits. Additionally, finance charges become a primary source of income for such institutions and entities. These charges are assessed against loans, credit cards, or lines of credit. These charges include annual fees for a credit card, account maintenance fees, account transaction fees, late payment for a credit card, or late-fee charges on loans. Finance charges also may be assessed when purchasing on credit or acquiring a loan for the reasons like:
- Interest rate percentage above 0% in account
- Account balance at the beginning of a billing cycle is more than 0
- No grace period for making a payment
How to Calculate Finance Charges?
Different creditors utilize various methods to determine finance charges. Even within the same category of loans, the fees can be disparate and difficult to understand. Here are a few examples of more common equations to help you understand the costs of a loan you may be considering.
Credit Card finance charges: Multiply your average daily balance by the APR (Annual Percentage Rate) and the days in your billing cycle. Then divide the product by 365 (the number of days a year).
Credit Card Finance Charge = (Average daily balance x Annual Percentage Rate x Days in a billing cycle)/365
Loan finance charges: In the case of loans, you can calculate the total monthly payments, including interest, and subtract them from the principal amount. The difference will reflect the finance charge associated with the loan.
Loan Finance Charge = Total monthly payments – Principal Amount
Finance Charge Examples
Here are a few examples to simplify the concept:
Case 1. Finance charge on a mortgage
Suppose you take a mortgage loan from a financial institution for 30 years. You borrowed a total of $132,000. The bank informs you about the fixed interest rate of 7% you will have to pay when reimbursing the loan.
| Maturity | 30 years |
| Amount | $132,000 |
| Interest | 7% |
| Repayment | $184,000 |
| Finance charges | $50,000 |
The additional $50,000 you pay is the finance charge (interest) incurred for getting a mortgage.
Case 2. Finance charges on credit cards
Let’s say you charge $500 on a card. You make the payment of $250 but fail to pay the entire amount by the due date. Once the due date arrives, your balance will go down to $250. Your average daily balance will remain $250, with some charges imposed by the issuer if you do not use your card or make payments. Suppose you have 25 days in the cycle with 18% as the APR.
| Average daily balance | $250 |
| Days in the billing cycle | 25 |
| APR | 18% |
| Amount | $1,125 |
| Finance charge | $3.08 |
Here’s how the formula works:
$250 x 0.18 x 25 = $1,125
$1,125/365 = $3.08
Thus, $3.08 will be your finance charge in the subsequent statement.
How to Avoid Finance Charges?
You may have observed how finance charges will increase the amount you have to repay when borrowing money. Is there any way to avoid these charges and optimize your personal finance? Some practices to help reduce or avoid finance charges depend on your loan type.
Most credit cards allow you to steer clear of the interest and fees if you pay your entire statement balance before the due date. Then when your new billing cycle begins, you will start with a zero balance and zero interest charges. Always be sure and check the details of your credit agreement.
When you have longer-term loans like mortgages or car loans, you can save quite a bit by making additional monthly payments on your loan’s principal. When the principal is reduced, the interest charges are reduced, and you will pay off your loan earlier than scheduled.
Conclusion
You should always understand the finance charges you incur when using loans or credit. It may not be possible to avoid or eliminate all finance charges. But you can usually apply some measures to reduce them. Maintaining a stable and positive credit score can significantly help you lower the finance charges associated with the lender. We recommend you always evaluate the fees before signing any loan agreement.
Frequently Asked Questions
What is the typical interest rate on PayDay Loans?
Payday loan transactions have an average interest rate of $1000 per month over 12 months. This comes out to be around $12,000 over 1 year.
The average interest rate may not be the same. It will vary depending on the size and duration of the loan, whether or not the borrower has repaid his loan, and other factors.
For example, an interest rate that is lower than usual if the loan is paid back. If you haven’t yet repaid your loan, however, the interest rates may be higher.
The interest rate on a loan will rise if the customer holds it longer than the due date. This is because a customer who has not paid back the loan in full will be more likely to default.
The interest rate will be higher if you take out a loan for 6 rather than 3 months.
What should you consider when applying online for a payday lender?
It is essential to know what you are signing for when you apply online payday loans.
Different options are available depending upon where you live, your budget and what you can afford.
It is important to thoroughly research the company before you apply. You should not sign anything if they don’t give enough information.
These are key factors to remember before you take out a payday loan.
- Information regarding their fees, penalties, repayment terms
- Contact information, including phone numbers and email addresses.
- You can prove that they are licensed in your state
- Information about other services that they offer (such faxless payday loans)
- You can contact them directly via their site using the contact form
- You have the right to cancel your agreement at any time without paying penalties
- A loan is possible even if you have a previous loan from another lender
- How soon will you receive the funds once your application was approved?
- There are no hidden fees or charges that can be added to your bill.
- How long it takes you to repay your loans
- What happens to your payments if they aren’t made?
- Your right to dispute the debt
- If there is a problem with their loan, they can sue them.
- How likely they are to report your payment history as a collection agency
- Their policies regarding late payments and defaulted loans
- The time they keep your records
- Their customer service
- They respond quickly to messages
- What happens if the company closes?
- It is so easy to find another lender
- What do you do if you have a problem
- Where do they stand on charging hidden fees
- How can they tackle identity theft problems?
- What happens if it goes wrong
- What type of security measures are they using?
- Does the company require you to be a resident of certain states
- They can perform third-party inspections
- Are they BBB certified?
- Are there any complaints that have been posted?
- How to complain/file a complaint
- What laws protect consumers who use online lenders
How can I quickly get money without a loan
A job that you enjoy is one you should be able to earn a living doing. This might mean that you take on a part-time position until you gain enough experience.
Once you have built up some skills, you should start looking for a full-time job.
You might also consider freelancing on websites like odesk.com/elance.com.
What apps let you borrow money immediately?
Asking for help is the best way you can find an app to borrow money. It is possible that your friends are already using the app.
Look at Trustpilot’s reviews to find out if they have. They can often provide a review of the app’s features.
Try searching online for “app+borrow money” to see what you find.
Google Trends can be used as well. Searching for “instant loan” gives you a list of popular instant loan apps.
Statistics
- By comparison, APRs on credit cards can range from about 12 percent to about 30 percent. (consumerfinance.gov)
- For example, CashUSA’s payday loan APRs range from 5.99% to 35.99%, placing them well within the averages for most major lines of credit, including credit cards and bank loans. (timesunion.com)
- Cons Up to 8% origination fee (abcactionnews.com)
- Those protections include a cap of 36 percent on the Military Annual Percentage Rate (MAPR) and other limitations on what lenders can charge for payday and other consumer loans. (consumerfinance.gov)
- Upgrade The company offers a 3 percent cash back on Auto, Health, and Home categories and a 1 percent cash back on the rest. (abcactionnews.com)
External Links
consumerfinance.gov
americanbanker.com
How To
How does a payday loan work?
Payday loans allow you to pay off short-term debts quickly. You can also get money when your finances are tight. Payday loan companies generally require that borrowers repay the debt within two week. However, lenders may offer extended repayment terms for customers who agree to higher interest rate. The amount borrowers will pay depends on the state regulations. Borrowers who are able to apply for multiple loans may end up in debt. Many lenders charge extra fees for additional loans.
To be eligible to borrow a payday cash loan, applicants need to prove their income and work. Lenders may also ask prospective customers if they have had difficulty making ends meet in recent times. This could indicate that the borrower may have difficulty paying existing loans. Lenders are often suspicious of borrowers who take out multiple loans quickly from different sources. This practice is known as “rollover”. Most states ban rollovers without approval from lenders.
After a lender approves the customer’s application, the applicant will receive a check by mail within 24 hours. The amount of the loan varies depending on which state it originated. It may range from $100 up to $1,500. These loans have steep penalties for late payment. Borrowers should make sure they are able to pay their bills on time. Borrowers use the funds to pay their bills, and then send payment records to lenders to show that they have paid the loan back.
Lenders will typically make automatic withdrawals from the borrower’s bank accounts each month so that borrowers don’t have to worry if they miss payments. Payday loans don’t have this option. Instead, borrowers usually receive one lump sum at the beginning of the month, meaning they may have to wait until the next paycheck to repay the loan. The monthly repayments of borrowers are also subject to fees from lenders after payment of the initial fee. This increases in time. In general, fees can range from $10-25 per $100 borrowed. A $300 loan would result in $30 total.
Borrowers who miss multiple payments could lose their access to additional funds. A majority of payday loan providers limit the time that borrowers can borrow money. Borrowers can usually only extend their loan terms a few times, unless they pay off the whole amount before due.
The majority of payday loan consumers are happy with the products and services offered by their lenders. Payday loans come with some risks, such as a poor credit history or insufficient savings. Payday lenders are more likely to lend money to people with poor credit ratings than they are to save.
