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Finance charge is a money term you need to understand. Here’s what it means.
What is a finance charge?
A finance charge is the cost of borrowing money, including interest and other fees. It can be a percentage of the amount borrowed or a flat fee charged by the company. Credit card companies have a variety of ways of computing finance charges.
A finance charge is usually added to the amount you borrow, unless you pay the full amount back within the grace period . In some instances, such as credit card cash advances, you need to pay a finance charge even if you pay the amount in full by the due date.
Finance charges vary based on the type of loan or credit you have and the company. A common way of calculating a finance charge on a credit card is to multiply the average daily balance by the annual percentage rate (APR) and the days in your billing cycle. The product is then divided by 365 .
Mortgages also carry finance charges. When you take out a mortgage, you typically have to pay interest as well as discount points, mortgage insurance and other fees. Anything above the principal on the loan is a finance charge.
To find out how much you will pay in finance charges over the course of a fixed term mortgage, multiply the number of payments you’ll make by the monthly payment amount. Then, subtract the amount of the loan’s principal.
Finance charge example
Say you charge $500 on a credit card this month. You pay $250 by the due date but are unable to make the full payment. Once the due date passes, your card balance is $250. If you don’t use the card next month and don’t make any payments, your average daily balance remains $250, and you will pay a finance charge on that amount.
When the next billing cycle closes, the card company multiplies the $250 by your APR and the days in the billing cycle. If you have 25 days in a billing cycle with an APR of 18 percent, the card company multiples 250 by 0.18 and by 25 to get $1,125 and then divides by 365 to get $3.08. The $3.08 will be the finance charge on your next statement.
If you’re carrying credit card debt, use our credit card calculator to find out how long it will take for you to pay off your debt.
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