A finance charge is one of the costs of borrowing money on credit. Finance charges include interest on balances and any extra fees that the credit-issuing entity can legally collect.
Learn some common examples of finance charges that you might face and some tips for reducing the impact of these fees.
Definition and Example of a Finance Charge
A finance charge is any cost you encounter in the process of obtaining credit, using it, and repaying the debt. Finance charges usually come with any form of credit, whether a credit card, business loan, or mortgage. Any amount you pay beyond the amount you borrowed is a finance charge.
Credit cards are the most common way that consumers obtain credit. One of the perks of having a credit card is that you can borrow money without paying off your balance in full every month. However, taking your time to repay your debt comes at a price. Your card issuer will charge interest on any balance you don't pay off by the end of the month. The interest cost is a finance charge.
If you miss a minimum payment deadline that falls outside of a grace period your credit card might have, 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 third quarter of 2021, American household debt totaled more than $15.2 trillion. Most of that debt (if not all) also has finance charges such as interest charges and loan-processing fees.
How Does a Finance Charge Work?
Finance charges are calculated each billing cycle based on the current prime rate, which banks charge their most creditworthy customers. This rate fluctuates in response to market conditions and Federal Reserve monetary policy, so any finance charges could vary monthly if your rate isn't fixed. 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.
Any credit card billing errors you've disputed in writing won't be assessed as a finance charge while your issuer investigates your dispute.
Creditors have different methods for determining finance charges. For example, 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 can be 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, it will 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 it 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.
Mortgages separate monthly payments into principal and interest payments in addition to extra costs like property taxes. The "principal" portion of payments doesn'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 to cover interest charges. Since your balance isn't decreasing significantly, you'll face another interest charge during the next billing cycle. Therefore, you'll need to increase your minimum payment if you want to pay off your balance and avoid finance charges.
If you have substantial credit card debt, a minimum payment is not likely to cover the month's finance charge. In that case, paying the minimum will result in a bigger balance. Therefore, reducing debt requires payments that are more than the minimum.
Types of Finance Charges
The Consumer Financial Protection Bureau (CFPB) has an exhaustive list of fees you might pay for any number of reasons on various debts you might have. Here are a few of them:
- Premiums or other charges
- Carrying charges
- Transaction fees
- Appraisal fees
- Finder's fees
- Activity fees
- Service fees
- Loan fees
- Finance charges include interest charges, late fees, loan-processing fees, or any other cost beyond repaying the amount borrowed.
- Finance charges fluctuate for many forms of credit as market conditions and prime rates change.
- A finance charge is a cost imposed on a consumer who obtains and uses credit.