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What Is a Finance Charge on a Personal Loan?

What Is a Finance Charge on a Loan?
Jason Steele
Jason SteeleUpdated February 27, 2023
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
When you borrow money, such as taking out a personal loan, there are costs involved in doing so. That’s called a finance charge, and it’s essentially the cost of borrowing money through a loan or credit cards. A finance charge on a loan may include interest and fees. Here’s a look at what finance charges on a loan may consist of and how they work.

Finance Charge on a Loan, Explained

What is a finance charge on a personal loan? Finance charges are a way for lenders to make money from lending funds to borrowers. A loan finance charge can be a one-time fee, like an origination fee, or a recurring fee, like interest rates. It could be charged as a flat fee, or a percentage-based fee, like APR.

Types of Finance Charges on a Loan

There are multiple types of finance charges that may apply to a loan. They include:

Prepayment Penalties

If you pay off a loan early, some lenders charge fees called prepayment penalties. The reason: When a borrower pays a loan in full before the end of the loan term, the lender loses money on interest charges. Not all lenders charge prepayment penalties. If a loan does have a prepayment penalty, it must be disclosed by the lender, according to the Truth in Lending Act. Check the loan contract for this charge, or ask the lender, before signing. 

Late Fees

You may be charged a late fee if you don’t make a loan payment by the due date. Late fees generally range from approximately $25 to $50. 

Origination Fees

An origination fee is a fee for a personal loan origination, which is the cost of processing your loan. This fee is typically about 1% to 5% of the loan amount, but it could be even higher.  An origination fee may be folded into the cost of your loan so that you pay it off over time as part of your regular loan payments. Or the fee may be deducted upfront from the amount of money you’re borrowing. 

Annual Percentage Rates (APRs)

The annual percentage rate (APR) on a loan is the total yearly cost to borrow money from a lender. The APR consists of the interest rate plus any fees, which may include late fees and the origination fee. The lower the APR, the less the loan will cost you.

Interest Rates  

One type of personal loan finance charge is the interest rate, which is a percentage of your principal loan amount. It’s the amount of money you’re charged for the loan. Interest rates can be variable or fixed. Variable interest rates can change over the course of the loan, while fixed interest rates stay the same. Interest rates are set by the lender. Usually, the higher your credit score, the lower the interest rates you may qualify for. Other factors, like your credit history, can impact your interest rate as well. If you have a personal loan, or you’re considering taking one out, you can get personal loan interest rates explained to you by contacting your lender.

The Finance Charge Formula

There is no one specific formula for the finance charge on a loan. Finance charges may be in the form of a percentage fee or a flat fee. An example of a percentage fee finance charge is an APR, while an example of a flat fee finance charge would be an application fee. 

Finance Charges by Loan Type

Different types of loans may have different kinds of finance charges. Here are some common loans and the finance charges they might come with. 

Auto Loan

An auto loan to buy a new or used car might have finance charges such as an origination fee, late fees, APR, and interest on the loan balance.

Student Loan

There are two types of student loans — federal and private student loans. Both types may have finance charges like late fees, APR, and interest on the loan balance. Some student loans start accruing interest while you’re still in school, while others don’t start accruing until after graduation. 

Home Loan

Home loans consist of mortgages, which are used to pay for the purchase of a home, as well as loans that allow you to tap into your home equity for borrowing, such as a home equity line of credit (HELOC). A mortgage typically has finance charges like closing costs, origination fees, late fees, APR, and interest on the loan balance. Fees on a HELOC usually consist of closing costs and interest rates.

Personal Loan

How personal loans work is that after you’re approved for a loan, you receive a lump sum of money that you pay back over time. It’s wise to understand the risks and rewards of personal loans. For instance, personal loans can be used for a variety of purposes, such as paying medical bills or making home improvements. But they do have finance charges. These charges may include origination fees, APR, late fees, and interest on the loan balance. Before you apply for a personal loan, find out what the finance charges are and how much they will cost you.

Can You Avoid a Finance Charge on a Loan?

Some finance charges are avoidable, while others are not. For instance, not all lenders charge prepayment penalties or origination fees. You can shop around for a lender who does not include these finance charges. Certain late fees can be avoided by making your loan payments on time and paying at least the minimum amount due. To avoid missing or forgetting payments and incurring late fees, set up autopay. Some lenders may even give you a small discount for using it. 

What Happens if You Don’t Pay a Finance Charge on a Loan?

Repercussions of not paying a finance charge on a loan may depend on the type of finance charge, the loan, and the lender. In general, failing to pay some finance charges could result in even more charges. And if you continue to avoid paying these charges, you may face serious consequences like your loan going into default

Finance Charges and Regulation

There are regulations on finance charges. For instance, the Truth in Lending Act requires all interest rates, standard fees, and penalty fees to be disclosed to borrowers. And the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009 requires a minimum of 21 days before interest can be charged on new credit card purchases. 

The Takeaway

Finance charges on a personal loan are the cost of borrowing money and typically include things like interest and certain fees. You may be able to avoid some finance charges, such as prepayment penalties and origination fees, and potentially save money. Shop around for lenders who don’t impose these fees.Understanding finance charges can help you compare personal loan options to find the best fit for your needs. And Lantern by SoFi can help. By filling out one simple application, you can compare offers from multiple lenders at once to find the lowest rates and fees, and the most beneficial terms.

Frequently Asked Questions

What are finance charges on loans?
How are finance charges on a loan and interest rates related?
Is a finance charge on a loan bad?
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About the Author

Jason Steele

Jason Steele

Jason Steele has been writing about credit cards and award travel since 2008. One of the nation's leading experts in this field, he has contributed to dozens of personal finance and travel outlets and has been widely quoted in the mainstream media.
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