It's easy to forget that banks and other lending institutions actually need to earn money themselves. One way credit card companies and banks make a profit is by charging customers for the privilege of borrowing their money. Any additional fee added to the original amount of a loan can be called a finance charge. This definition of finance charge includes the interest added to the balance, service fees for transactions, late fees, and balance transfer fees.
When a customer receives a $1000 USD loan from a bank, for example, the bank has the legal right to charge interest based on the current federal prime lending rate. If this interest rate were a fixed 10%, the eventual 'cost' of borrowing the original $1000 would be at least $1100, the amount of the loan plus a $100 finance charge. But this isn't the end of the story.
Banks and credit card companies also expect a minimal payment to be made by a specified time of the month. Customers may have a few days after that date (called a grace period) to send off their bill, but payments received late can be assessed late fees or another finance charge. The terms of these penalty fees must be spelled out in writing under a federal Truth-in-Lending Act. If a customer can pay off the entire balance due before the grace period ends, no finance charge should be incurred. But most credit card holders have substantial balances remaining on their accounts, which means the bank or credit card company can legally add a percentage of that balance to the total amount owed.
Some may feel that banks and other lending institutions exploit the system by creating an impossibly strict finance charge policy. The truth is that all banks and other lenders must periodically report their practices to a federal board which oversees fair lending practices. As long as a bank or lender reports all the potential forms of a finance charge in writing and the borrower agrees to those terms, there is little legal recourse. This is why bank loan officers encourage borrowers to read the terms of the loan contract carefully before signing.
A standard finance charge such as interest payments or late fee should be anticipated as the cost of borrowing money. Consumers looking for the best loan arrangements should compare different rates offered at various banks and credit unions to get the best terms possible.
