A finance charge is a cost imposed on a consumer for obtaining credit. Finance charges include interest on debt balances and any extra fees imposed by the credit-issuing entity.
Below, you'll find common examples of finance charges that consumers face, and some tips for reducing the impact of these fees.
What Is a Finance Charge?
A finance charge is any cost a consumer encounters in the process of obtaining credit and repaying debt. Finance charges usually come with any form of credit, whether it's a credit card, a business loan, or a mortgage. Any amount you pay beyond the amount you borrowed is a finance charge.
Credit cards may be the most common way that consumers obtain credit. One of the perks of having a credit card is that you can borrow money without having to pay off your balance in full every month. However, taking your time to repay your debt comes at a price. Your issuer will charge interest on any balance not paid off by the end of the month. That interest cost is a finance charge. If you miss a minimum payment deadline that falls outside of a grace period for your credit card, you could be charged a late payment fee, which is another example of a finance charge.
Financing debt is big business in the U.S. In the first quarter of 2020, American household debt totaled $14.3 trillion. That's a 1.1% increase since the fourth quarter of 2019, when household debt was already 26.8% higher than it was in 2013. Most of that debt (if not all of it) will come with finance charges such as interest charges and loan processing fees.
How Does a Finance Charge Work?
Finance charges are calculated each billing cycle based upon the current prime rate. As of July 15, 2020, the Wall Street Journal calculated the prime rate to be 3.25%. This rate fluctuates in response to market conditions and Federal Reserve policy, so your potential finance charge could vary monthly. If you have a fixed-rate loan, the finance charge is less likely to vary, though it may still fluctuate based on factors such as your payment history and timeliness.
For credit cards, any billing errors that you've disputed in writing won't be assessed as a finance charge while your credit card issuer investigates your dispute.
Creditors have different methods for determining finance charges. Credit card issuers may calculate finance charges using your daily balance, an average of your daily balance, the balance at the beginning or end of the month, or your balance after payments have been applied.
Your credit card agreement may also include a minimum finance charge that's applied anytime your balance is subject to a fee. For example, your credit card terms may include a $1 minimum finance charge, so if a billing cycle's charges are $0.65, that'll be rounded up to $1.
You can reduce the amount of interest you pay by reducing your balance, requesting a lower interest rate, or moving your balance to a credit card with a lower interest rate. You can avoid finance charges on credit card accounts altogether by paying your entire balance before the grace period ends each month.
Finding Charges on a Bill
Finance charges can be listed in several places on your monthly credit card billing statement. On the first page of your billing statement, you'll see an account summary listing your balance, payments, credits, purchases, and any interest charges.
In the breakout of transactions made on your account during the billing cycle, you'll see a line item for your finance charge and the date the finance charge was assessed.
In a separate section that breaks down your interest charges, you'll see a list of your finance charges by the type of balances you're carrying. For example, if you have a purchase balance and a transfer balance, you'll see details of the finance charges for each. Different types of transactions and balances may come with different interest rates and grace periods.
For mortgages, monthly payments are separated into principal and interest payments, in addition to extra costs like property taxes. In this case, the "principal" portion of payments wouldn't qualify as a finance charge—it simply goes toward reducing your debt balance. The interest payments, on the other hand, are a finance charge.
Paying Off a Finance Charge
Making your minimum credit card payment is usually enough to cover your finance charge plus a small percentage of the balance. However, if you're only paying the minimum payment, your balance won't decrease by that much—it takes the bulk of a monthly payment just to cover interest charges. Since your balance isn't decreasing significantly, you'll face another interest charge during the next billing cycle. You'll need to increase your minimum payment if you want to pay off your balance and avoid finance charges.
For those with substantial debt, the minimum payment may not cover the month's finance charge. In this case, paying the minimum will result in a bigger balance. Reducing debt will require payments beyond the minimum.
- A finance charge is a cost imposed on a consumer who obtains credit.
- Finance charges include interest charges, late fees, loan processing fees, or any other cost that goes beyond repaying the amount borrowed.
- For many forms of credit, the finance charge fluctuates as market conditions and prime rates change.