What Exactly IS a Finance Charge?
By Jill Terry
You’ve just been approved for a car loan. You’re presented with a legal-size document called a “Truth in Lending” disclosure and asked to sign it. Scanning the document to verify that the monthly payment is an amount you can handle, you sign, accept your copy in a fog of new car bliss, and never look at the document again.
Did you know that this document is supposed to be a tool you can use to shop for the best financing? It’s true–anybody who acts as a creditor is required to give you, at your request, a Truth in Lending statement before you engage in a transaction so you can decide whether you want your loan financed by that company or bank.
So, in a best-case scenario, you go to several car dealers (or banks, depending on the kind of loan you need) and ask them to provide you with a preliminary Truth in Lending statement so that you can see how much your credit is going to cost. But how will you know a good loan from a bad loan?
Check out the Annual Percentage Rate (APR), which is the percentage cost of credit on a yearly basis. A major component of the APR is the interest rate, but it’s a rare occasion when the APR and interest rate are the same. Why? Because lots of fees called finance charges are also factored in. Comparing only interest rates will not give you an accurate picture of how much the credit will cost you. You must look at APRs because they represent the cost of interest rates plus finance charges.
Consumers have been told for decades that the APR is all they need to know to compare credit costs–a statement that is only partially true. Yes, the invention of the APR back in 1968 was a giant step towards standardizing the articulation of credit costs, but it’s an imperfect system. Because the law surrounding the question of whether or not a fee is a finance charge is incredibly murky and complex, not every cost associated with your loan will be classified as a finance charge and included in the APR.
Once again, it’s up to you, the consumer, to educate yourself about fees. For instance, a credit report fee is not a finance charge according to Regulation Z (the law that enforces the Truth in Lending Act), and if you deal with a bank that charges you for that report, that amount will not be factored into the APR. Yet, it’s a fee that you pay for, and it adds to the cost of your credit. Two creditors may disclose exactly the same APRs to you, and those APRs may be completely accurate under the law, but if one of those creditors charges other fees that are not technically finance charges, you are actually paying more for a loan from that creditor.
When you’re shopping for a loan, ask not only for an APR but also for a list of all fees associated with the credit. As you compare rates among other creditors and banks, look over the respective lists. Here is a comprehensive roster of fees that aren’t finance charges under the law. Look for them on your potential creditors’ lists so that you’ll know what is and isn’t included in the APR.
Fees That Are Not Finance Charges (includes residential mortgage transactions):