What it means
When you borrow $20,000, you will pay back more than $20,000. The total finance charge is that extra amount, and it is a clearer measure of cost than the headline interest rate because it also captures fees that are a condition of getting the loan.
Typical components include interest, loan origination fees, service charges, required credit insurance premiums and some mortgage-related charges. Costs that you would pay whether or not you borrowed, such as a standard registration fee or a late payment penalty, are generally not part of the finance charge.
The finance charge is closely tied to the annual percentage rate (APR), which expresses the cost of credit as a yearly rate that includes the fees. The charge shows the cost in dollars over the whole loan, while the APR shows it as a percentage per year, so the two are used together.
For consumers, the figure makes it possible to compare, for example, a loan with a low rate and a high fee against one with a higher rate and no fee. For businesses, it helps in comparing equipment finance, invoice financing and overdraft facilities, where fees are often hidden in the small print.
The total depends strongly on how long the loan runs. A longer term lowers the monthly payment but usually raises the total finance charge, because interest accrues for more months, so a cheaper payment is not the same as a cheaper loan.
Be careful when loans can be repaid early, because the actual charge then falls, but some lenders add prepayment fees that offset the saving. The disclosed figure assumes the loan runs its full term with every payment made on time.
In practice
Real-world examples.
Example
A shopper is offered two furniture loans, one at a lower interest rate with a $250 setup fee and one with a slightly higher rate and no fee. She compares the total finance charge of each over three years and chooses the one that costs $180 less in total.
Example
A small restaurant buys a $60,000 oven line on equipment finance. The lender's quote shows interest of $7,200 and a documentation fee of $600, so the owner records a total finance charge of $7,800 when planning cash flow.
Example
A graduate takes a personal loan to cover moving costs and discovers that the required credit insurance adds $400 to the cost. The finance charge on the disclosure is higher than the interest alone, and he decides to ask whether the insurance is optional.
Formula
Calculation
Total finance charge = Total of all payments - Amount financed
Here the amount financed is the loan principal minus any prepaid finance charges that are deducted from the proceeds. Suppose a borrower takes a $20,000 car loan, and the lender deducts a $300 non-refundable origination fee, so the amount financed is 20,000 - 300 = $19,700. The loan is repaid in 48 monthly payments of $470, so total payments are 48 x 470 = $22,560. Total finance charge = 22,560 - 19,700 = $2,860, which is the interest of $2,560 plus the $300 fee.Case study
Seen in the real world.
Willowbrook Bikes is an illustrative, fictional retailer that offered customers in-store finance on electric bikes costing $3,000. The first plan advertised a low monthly payment but ran over 60 months, and a customer service review found that buyers were surprised at how much extra they paid.
The finance manager worked out the figures. Over 60 months at a payment of $62, the total of payments was 60 x 62 = $3,720, so the finance charge was $720 on an amount financed of $3,000. A 36-month plan with a $94 payment led to total payments of $3,384 and a finance charge of just $384.
The shop began to show the total finance charge beside the monthly payment on every quote. In the illustrative months that followed, more customers chose the shorter plan, complaints fell and the business reduced its exposure to late payments.
Watch out
Common mistakes.
- Choosing a loan on the monthly payment alone, when a longer term can make the total finance charge far higher.
- Assuming the finance charge is the same as the interest, when required fees and insurance premiums are often included.
- Ignoring the finance charge on a promotional offer, such as zero interest with a high setup fee, where the fee is the whole cost.
Questions
People also ask.
Is the total finance charge the same as the APR?
No, the finance charge is a total in dollars over the life of the loan, while the APR is an annual percentage that includes certain fees and lets you compare loans of different sizes.
Does paying a loan off early reduce the finance charge?
Usually yes, because less interest accrues, though some loans carry prepayment penalties or use methods that reduce the saving.
Are late fees part of the total finance charge?
Generally no, because they depend on the borrower's behaviour rather than being a required cost of getting the credit.
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