A finance charge refers to the overall cost of borrowing money. This is inclusive of interests and fees incurred. Most time, it reflects the percentage of the amount borrowed or a flat fee charged by the credit facility. Furthermore, credit companies vary with different ways of computing finance charges. Learn more about finance charges with their accrual periods in our detailed guide below.
Finance Charge Formula Definition
A finance charge touches on the added amount you borrow from a credit facility. However, the finance charge does not apply when you pay the full amount within the grace period. The charge represents the credit facility’s compensation for credit services rendered.
Each finance charge varies depending on the type of loan you apply for and the apparent credit facility. The most popular technique for calculating the finance charge on a credit card is multiplying the average daily balance with the annual percentage rate—also, the days within the billing cycle. Afterwards, you can divide it by 365.
How to Calculate Finance Charge
What is a finance charge in math? A finance charge is a fee charged for the use of borrowed money. Finance charges are most commonly associated with credit cards but may apply to all types of consumer loans.
A finance charge is defined as the sum of interest, fees, and other charges that a borrower incurs by using credit. This fee is charged on top of the borrowed amount.
Finance charges are calculated based on the methods stated in your loan agreement or credit card statement. It can be calculated on a daily, monthly or yearly basis and added to your outstanding balance.
The finance charge you pay depends upon:
- The annual percentage rate (APR)
- The outstanding balance in your account
- The number of days you carry a balance
Finance Charge Formula
The formula while using a finance charge calculator is given below;
Finance Charge = Interest Rate x Amount Borrowed
Where;
Interest Rate = Annual Interest Rate /365 * Number of Days from Last Payment to Current Billing Statement
Amount Borrowed = Average Daily Balance
Finance Charge Calculation Method
Finance charges are calculated differently depending on the type of loan. On mortgages and auto loans, finance charges are calculated based on an annual interest rate and then broken down into monthly charges. The formula to calculate a monthly finance charge on a mortgage is:
Monthly Finance Charge = (Annual Percentage Rate/12) x Average Daily Balance
On credit cards, finance charges are usually calculated using one of two methods: average daily balance or adjusted balance. The average daily balance method is calculated by adding all monthly balances and dividing them by the number of days in the billing cycle.
The adjusted balance method takes the ending balance from the previous statement, subtracts any payments made during the current billing cycle, and adds any new purchases made.
What Are the 4 Ways in Which Finance Charges Are Calculated?
Finance charges are calculated in different ways. The four main types of finance charges, including interest rate calculation, amount financed, annual percentage rate, and balance computation methods, are explained below.
Interest Rate
This is the most common type of finance charge. It is calculated about the amount borrowed.
Amount Financed
This is the amount borrowed minus upfront fees, such as application fees and closing costs.
Annual Percentage Rate
This is the total cost of borrowing money for a year, including interest rates and fees.
Balance Computation Method
The lender calculates an average daily balance over a billing cycle by adding the balances on each day and dividing that number by the number of days in that billing cycle.
How Do You Calculate Finance Charge With Average Daily Balance?
The average daily balance method is most commonly used to calculate finance charge for credit cards. It usually applies to revolving credit accounts, which allow you to carry a balance from month to month and pay off all or some of it. With this approach, you will be charged interest on your entire daily balance during each day of your billing cycle.
Here is how the average daily balance is calculated:
- Take the ending balance from each day of the billing cycle and add them together.
- Divide that total by the number of days in the billing cycle, ranging from 28 to 31 days.
How to Calculate Finance Charge on a Car Loan?
How do you calculate the finance charge on a car loan? To calculate the finance charge on a car loan, you need to multiply the average daily balance by the daily rate (APR divided by 365 days). The result is the interest charged for that billing cycle. Multiply that number by the number of cycles in the year for your annual interest rate.
Let’s take a look at an example:
You buy a $20,000 car with no money down and pay it off over 60 months. You have negotiated an APR of 3.75%. Your monthly payment will be $373.22, but that payment includes some interest, as you can see in Table 1.
The interest paid each month will decrease as you pay off your balance, and after five years, your loan will be paid off. The above example shows that you will pay $2,779.69 in total interest.
How to Calculate Finance Charge on Auto Loan
You will pay interest on the outstanding balance when you take out a loan. The interest rate applied to the loan depends upon several factors, such as your credit score, income, and down payment. The bank or finance company determines the interest rate you will be charged when applying for a loan.
However, you can calculate the amount of interest you will be paying on a loan by applying the simple formula to determine finance charges.
To calculate the finance charge on any loan, you will need to know several pieces of information:
● The amount of money that was borrowed (also known as the principal)
● The term or length of time it takes to repay the loan in full
● The annual percentage rate (APR) stated in the contract
Using these pieces of information, you can calculate exactly how much interest you will be paying throughout your auto loan.
Final Takeaway
If you are ever taking out a loan, you need to calculate your finance charge. The finance charge might not be the only thing to consider, but it is a significant amount that will affect your ultimate costs. The finance charge will be the interest charged on your credit card if you do not qualify for a 0% APR rate or any promotional period offered by the business.
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