How to Calculate Finance Charges

A Finance charge generally refers to the cost of borrowing. It will not only incorporate the principal amount, but will also include all related costs such as maintenance fee and late charges. It is not entirely necessary to compute your own finance charge as most lenders and banks will do it for you.

However, knowing about it will always help you realize the amount or expected amount you will need to pay or will be charged for the service you have obtained. While there are several ways to calculate finance charges, and your lender will probably be using complex formulas, it is important to understand the basics.


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    Understanding finance charges

    It is important to note that nothing comes for free. Banks and other financial institutions are all looking to increase their profits and earn more. The services they will be providing, for short and long term purposes, will not only have certain collateral attached with them, but extra charges as well.

    However, in short term scenarios, they will not be making extra money if the borrower decides to return the amount on or before the due date – as is the case with credit card payments etc. On the flip side, failure to pay the money on time will result in a variable interest rate applied by the lending company which will increase proportionately.

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    Basic calculation

    The basic calculation for a loan includes two important elements – Principal and interest. Principal refers to the money being borrowed from the lender for various purposes such as buying a car, house or service etc. Interest on the other hand will refer to the amount made by the lender on the money or service he or she has given out. To keep our discussion simple, we will be using a flat rate, with no variable changes.

    It will be calculated by taking into account the principal amount, rate and time. For instance if the principal amount of buying a car is $1,000 and the rate is 10%, with the payment being made in 2 years, then the amount paid in interest over the 2 years will be:

    Interest= principal ($10,000) x rate (10% or 0.10) x 2 = 200

    The total amount which needs to be paid back will be the principal amount plus the interest amount which will be equal to $1000+200= $1200

    If you will be making for instance weekly payments over two years, your amount will be 1200/ 104= $11.53 per week.

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