What are finance charges?

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In the U.S. consumer finance industry, a finance charge refers to any fee charged by a lender that is part of the cost of credit or borrowing a loan.

Finance charges include almost all fees payable to and required by a lender in order to issue a loan to a borrower. A finance charge can also be an amount charged by a lender on an outstanding balance of a loan, such as late charges and prepayment penalties. The bulk of most consumers’ loan finance charges relate to the interest charged by a lender for the loan, but finance charges also include additional fees charged by the lender. These additional fees can be one-time expenses, or they can be recurring charges.

Each lender can establish its own set of finance charges – such as individual fees and interest rates – as long as the fees or interest rates do not exceed specific predatory lending guidelines established by state and federal agencies. Such limits will vary by loan type, as well as by locale.

Types of finance charges

Common finance charges, besides the interest rate charged on the loan, include loan discount points, origination fees, finder’s fees and loan broker fees.

Finance charges are not issued solely by the institution placing the loan, but can also include fees for services from other companies. For example, a lender may also require a credit report to determine the borrower’s loan eligibility and collect a credit report fee, which will be forwarded to the credit reporting agency. Or the borrower may have gone through a loan broker who charged a brokerage fee to arrange the loan. In both instances, the fees are requirements to close the loan — but are charged by third parties (not the lender). Nevertheless, these are still considered finance charges.

Not all fees involved in the loan process, however, are necessarily considered finance charges. For example, most property inspection, title examination, notarization, settlement services and appraisal fees are not considered finance charges. The rule of thumb in the mortgage loan industry is that if the same fees exist with cash purchases (without any loans), then it’s probably not a finance charge.

APR vs interest rates

Finance charges play an integral part in government-required loan disclosures that must be provided to consumers who receive financing or mortgage loans. In particular, finance charges are necessary to calculate the annual percentage rate (APR). The APR is a number that expresses the cost of money borrowed expressed as an annual rate. The APR considers the loan amount, term and applicable finance charges.

For example, if a consumer loan with an amount of $5,000 and an interest rate of 7.00 percent over five years is issued, the monthly payment is $99.01.

If that same lender has a $50 application fee and a $10 credit report charge, the APR would be 7.5018 percent due to the additional finance charges totaling $60, spread out over the five-year term. A large disparity between the interest rate of a loan and the APR reflects a greater amount of loan-related fees required by the lender – on top of the interest rate.

Note that the finance charge includes the loan’s interest rate, as well as all other loan fees. Consequently, the APR is more than the interest rate and is rarely the same as the interest rate.

Finance charges and APR may be confusing, but they are actually useful pieces of information for consumers.

When comparing different prices for the same type of loan (from different lenders), the APR and finance charges help consumers get a clearer understanding of the true cost of their loans or credit offers. Because interest rate offers may hide other loan fees, the APR and finance charges provide a more precise way to compare similar loans and credit product.

Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.

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