Finance charge

Last updated October 23, 2019

In United States law, a finance charge is any fee representing the cost of credit, or the cost of borrowing. It is interest accrued on, and fees charged for, some forms of credit.^[1] It includes not only interest but other charges as well, such as financial transaction fees. Details regarding the federal definition of finance charge are found in the Truth-in-Lending Act and Regulation Z, promulgated by the Federal Reserve Board.

The United States of America (USA), commonly known as the United States or America, is a country comprising 50 states, a federal district, five major self-governing territories, and various possessions. At 3.8 million square miles, the United States is the world's third or fourth largest country by total area and is slightly smaller than the entire continent of Europe. With a population of over 327 million people, the U.S. is the third most populous country. The capital is Washington, D.C., and the most populous city is New York City. Most of the country is located contiguously in North America between Canada and Mexico.

A fee is the price one pays as remuneration for rights or services. Fees usually allow for overhead, wages, costs, and markup. Traditionally, professionals in the United Kingdom receive a fee in contradistinction to a payment, salary, or wage, and often use guineas rather than pounds as units of account. Under the feudal system, a Knight's fee was what was given to a knight for his service, usually the usage of land. A contingent fee is an attorney's fee which is reduced or not charged at all if the court case is lost by the attorney.

Interest, in finance and economics, is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum, at a particular rate. It is distinct from a fee which the borrower may pay the lender or some third party. It is also distinct from dividend which is paid by a company to its shareholders (owners) from its profit or reserve, but not at a particular rate decided beforehand, rather on a pro rata basis as a share in the reward gained by risk taking entrepreneurs when the revenue earned exceeds the total costs.

In personal finance, a finance charge may be considered simply the dollar amount paid to borrow money, while interest is a percentage amount paid such as annual percentage rate (APR).^[2] These definitions are narrower than the typical dictionary definitions or accounting definitions.

The term annual percentage rate of charge (APR), corresponding sometimes to a nominal APR and sometimes to an effective APR (EAPR), is the interest rate for a whole year (annualized), rather than just a monthly fee/rate, as applied on a loan, mortgage loan, credit card, etc. It is a finance charge expressed as an annual rate. Those terms have formal, legal definitions in some countries or legal jurisdictions, but in general:

Creditors and lenders use different methods to calculate finance charges. The most common formula is based on the average daily balance, in which daily outstanding balances are added together and then divided by the number of days in the month.

In financial accounting, interest is defined as any charge or cost of borrowing money. Interest is a synonym for finance charge. In effect, the accountant looks at the entire cost of settlement on a Housing and Urban Development (HUD) form 1 (the HUD-1 Settlement Statement) document as interest unless that charge can be identified as an escrow amount or an amount that is charged to current expenses or expenditures other than interest, such as payment of current or prorated real estate taxes.^[3]

The United States Department of Housing and Urban Development (HUD) is a Cabinet department in the Executive branch of the United States federal government. Although its beginnings were in the House and Home Financing Agency, it was founded as a Cabinet department in 1965, as part of the "Great Society" program of President Lyndon Johnson, to develop and execute policies on housing and metropolises.

The HUD-1 Settlement Statement is a standardized mortgage lending form in use in the United States of America on which creditors or their closing agents itemize all charges imposed on buyers and sellers in consumer credit mortgage transactions. The HUD-1 is used primarily for reverse mortgages and mortgage refinance transactions. The reference to 'HUD' in the form's name refers to the Department of Housing and Urban Development.

Related Research Articles

In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations etc. The recipient incurs a debt, and is usually liable to pay interest on that debt until it is repaid, and also to repay the principal amount borrowed.

Debt consolidation is a form of debt refinancing that entails taking out one loan to pay off many others. This commonly refers to a personal finance process of individuals addressing high consumer debt, but occasionally it can also refer to a country's fiscal approach to consolidate corporate debt or Government debt. The process can secure a lower overall interest rate to the entire debt load and provide the convenience of servicing only one loan or debt.

Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable to a third party at a discount. A business will sometimes factor its receivable assets to meet its present and immediate cash needs. Forfaiting is a factoring arrangement used in international trade finance by exporters who wish to sell their receivables to a forfaiter. Factoring is commonly referred to as accounts receivable factoring, invoice factoring, and sometimes accounts receivable financing. Accounts receivable financing is a term more accurately used to describe a form of asset based lending against accounts receivable. The Commercial Finance Association is the leading trade association of the asset-based lending and factoring industries.

A reverse mortgage is a mortgage loan, usually secured by a residential property, that enables the borrower to access the unencumbered value of the property. The loans are typically promoted to older homeowners and typically do not require monthly mortgage payments. Borrowers are still responsible for property taxes and homeowner's insurance. Reverse mortgages allow elders to access the home equity they have built up in their homes now, and defer payment of the loan until they die, sell, or move out of the home. Because there are no required mortgage payments on a reverse mortgage, the interest is added to the loan balance each month. The rising loan balance can eventually grow to exceed the value of the home, particularly in times of declining home values or if the borrower continues to live in the home for many years. However, the borrower is generally not required to repay any additional loan balance in excess of the value of the home.

Refinancing is the replacement of an existing debt obligation with another debt obligation under different terms. The terms and conditions of refinancing may vary widely by country, province, or state, based on several economic factors such as inherent risk, projected risk, political stability of a nation, currency stability, banking regulations, borrower's credit worthiness, and credit rating of a nation. In many industrialized nations, a common form of refinancing is for a place of primary residency mortgage.

Predatory lending refers to unethical practices conducted by lending organizations during a loan origination process that are unfair, deceptive, or fraudulent. While there are no legal definitions in the United States for predatory lending per se, a 2006 audit report from the office of inspector general of the Federal Deposit Insurance Corporation (FDIC) broadly defines predatory lending as "imposing unfair and abusive loan terms on borrowers", though "unfair" and "abusive" were not specifically defined. Though there are laws against some of the specific practices commonly identified as predatory, various federal agencies use the phrase as a catch-all term for many specific illegal activities in the loan industry. Predatory lending should not be confused with predatory mortgage servicing which is mortgage practices described by critics as unfair, deceptive, or fraudulent practices during the loan or mortgage servicing process, post loan origination.

The Truth in Lending Act (TILA) of 1968 is a United States federal law designed to promote the informed use of consumer credit, by requiring disclosures about its terms and cost to standardize the manner in which costs associated with borrowing are calculated and disclosed.

Credit is the trust which allows one party to provide money or resources to another party wherein the second party does not reimburse the first party immediately, but promises either to repay or return those resources at a later date. In other words, credit is a method of making reciprocity formal, legally enforceable, and extensible to a large group of unrelated people.

A good faith estimate, referred to as a GFE, was a standard form that had to be provided by a mortgage lender or broker in the United States to a consumer, as required by the Real Estate Settlement Procedures Act (RESPA). Since August 2015, GFE has been replaced by a loan estimate form, serving the same purpose but following slightly different guidelines set by CFPB, so as to reduce consumer confusion. A good faith estimate is a standard form intended to be used to compare different offers from different lenders or brokers. The estimate must include an itemized list of fees and costs associated with the loan and must be provided within 3 business days of applying for a loan. Since RESPA does not apply to Business Purpose Loans, no GFE is provided in those transactions.

Down payment, is an initial up-front partial payment for the purchase of expensive items such as a car or a house. It is usually paid in cash or equivalent at the time of finalizing the transaction. A loan of some sort is then required to finance the remainder of the payment.

Credit card interest is the principal way in which credit card issuers generate revenue. A card issuer is a bank or credit union that gives a consumer a card or account number that can be used with various payees to make payments and borrow money from the bank simultaneously. The bank pays the payee and then charges the cardholder interest over the time the money remains borrowed. Banks suffer losses when cardholders do not pay back the borrowed money as agreed. As a result, optimal calculation of interest based on any information they have about the cardholder's credit risk is key to a card issuer's profitability. Before determining what interest rate to offer, banks typically check national, and international, credit bureau reports to identify the borrowing history of the card holder applicant with other banks and conduct detailed interviews and documentation of the applicant's finances.

An overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero. In this situation the account is said to be "overdrawn". If there is a prior agreement with the account provider for an overdraft, and the amount overdrawn is within the authorized overdraft limit, then interest is normally charged at the agreed rate. If the negative balance exceeds the agreed terms, then additional fees may be charged and higher interest rates may apply.

This page gives descriptions of UK mortgage terminology which can often confuse borrowers.

Line of credit credit source extended to a government, business or individual by a bank or other financial institution

A line of credit is a credit facility extended by a bank or other financial institution to a government, business or individual customer that enables the customer to draw on the facility when the customer needs funds. A line of credit takes several forms, such as an overdraft limit, demand loan, special purpose, export packing credit, term loan, discounting, purchase of commercial bills, traditional revolving credit card account, etc. It is effectively a source of funds that can readily be tapped at the borrower's discretion. Interest is paid only on money actually withdrawn. Lines of credit can be secured by collateral, or may be unsecured.

The Real Estate Settlement Procedures Act (RESPA) was a law passed by the United States Congress in 1974 and codified as Title 12, Chapter 27 of the United States Code, 12 U.S.C. §§ 2601–2617. The main objective was to protect homeowners by assisting them in becoming better educated while shopping for real estateservices, and eliminating kickbacks and referral fees which add unnecessary costs to settlement services. RESPA requires lenders and others involved in mortgage lending to provide borrowers with pertinent and timely disclosures regarding the nature and costs of a real estate settlement process. RESPA was also designed to prohibit potentially abusive practices such as kickbacks and referral fees, the practice of dual tracking, and imposes limitations on the use of escrow accounts.

Mortgage loan loan secured using real estate

A mortgage loan or, simply, mortgage is used either by purchasers of real property to raise funds to buy real estate, or alternatively by existing property owners to raise funds for any purpose, while putting a lien on the property being mortgaged. The loan is "secured" on the borrower's property through a process known as mortgage origination. This means that a legal mechanism is put into place which allows the lender to take possession and sell the secured property to pay off the loan in the event the borrower defaults on the loan or otherwise fails to abide by its terms. The word mortgage is derived from a Law French term used in Britain in the Middle Ages meaning "death pledge" and refers to the pledge ending (dying) when either the obligation is fulfilled or the property is taken through foreclosure. A mortgage can also be described as "a borrower giving consideration in the form of a collateral for a benefit (loan)".

Credit card card for financial transactions from a line of credit

A credit card is a payment card issued to users (cardholders) to enable the cardholder to pay a merchant for goods and services based on the cardholder's promise to the card issuer to pay them for the amounts plus the other agreed charges. The card issuer creates a revolving account and grants a line of credit to the cardholder, from which the cardholder can borrow money for payment to a merchant or as a cash advance.

A bank is a financial institution that accepts deposits from the public and creates credit. Lending activities can be performed either directly or indirectly through capital markets. Due to their importance in the financial stability of a country, banks are highly regulated in most countries. Most nations have institutionalized a system known as fractional reserve banking under which banks hold liquid assets equal to only a portion of their current liabilities. In addition to other regulations intended to ensure liquidity, banks are generally subject to minimum capital requirements based on an international set of capital standards, known as the Basel Accords.

Financing cost (FC), also known as the cost of finances (COF), is the cost, interest, and other charges involved in the borrowing of money to build or purchase assets. This can range from the cost it takes to finance a mortgage on a house, to finance a car loan through a bank, or to finance a student loan.

References

↑ O'Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 513. ISBN 0-13-063085-3.
↑ Kapoor, Jack R.; Dlabay, Les R.; Hughes, Robert J. (2007). Focus on Personal Finance. Mcgraw-Hill/Irwin Series in Finance, Insurance and Real Estate (2nd ed.). Mcgraw-Hill. ISBN 0-07-353063-8.
↑ Giovetti, Al (2008). Accredited Business Accountant Review Course. Accreditation Council on Accounting and Taxation.

This finance-related article is a stub. You can help Wikipedia by expanding it.

This law-related article is a stub. You can help Wikipedia by expanding it.

This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.

[1] O'Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 513. ISBN 0-13-063085-3.

[2] Kapoor, Jack R.; Dlabay, Les R.; Hughes, Robert J. (2007). Focus on Personal Finance. Mcgraw-Hill/Irwin Series in Finance, Insurance and Real Estate (2nd ed.). Mcgraw-Hill. ISBN 0-07-353063-8.

[3] Giovetti, Al (2008). Accredited Business Accountant Review Course. Accreditation Council on Accounting and Taxation.