What is finance charge and how do you figure it out?
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Methods of calculating the finance charge on a charge account or credit card vary with the lender and the credit rating and payment history of the borrower. The finance charge includes a computed monthly interest payment on the total or average balance (unless the previous bill was paid full within about ten days after billing) plus various late payment fees and cash advance or balance transfer fees. There are also foreign currency conversion fees. Each charge account comes with a disclosure statement, which lenders often change to raise the finance charges.
A finance charge is the cost of borrowing money or obtaining credit, typically calculated as a percentage of the amount borrowed or the outstanding balance. It represents the total amount of interest and fees charged to the borrower.
To figure out the finance charge, you need to consider two main factors: the interest rate and the time period. Here is a step-by-step process to calculate it:
1. Determine the interest rate: Find out the interest rate associated with the loan or credit. It could be an annual percentage rate (APR) or a periodic rate (e.g., monthly or daily).
2. Determine the loan or credit balance: Identify the amount of the loan or the outstanding balance on the credit account for which you want to calculate the finance charge. This represents the principal amount on which interest will be charged.
3. Convert the interest rate to a decimal: If the interest rate is given as an APR of, for example, 12%, divide it by 100 to convert it to a decimal (i.e., 0.12).
4. Calculate the periodic interest rate: If the interest rate is expressed as a periodic rate (e.g., monthly), divide the converted decimal rate by the number of periods in a year (e.g., 12 for monthly).
5. Determine the time period: Identify the duration for which you want to calculate the finance charge. This could be a month, a year, or any other specific time frame.
6. Multiply the principal balance by the periodic interest rate: Multiply the loan or credit balance by the periodic interest rate to find the interest amount charged for the given period.
7. Repeat the calculation for each period: If the finance charge relates to multiple periods (e.g., monthly interest charges), repeat the multiplication for each period and sum up the results to get the total finance charge.
It is important to note that additional fees or charges, such as transaction fees or late payment fees, may also be included in the finance charge. Therefore, you should review the terms and conditions of the loan or credit agreement to ensure accuracy in calculating the finance charge.