How To Calculate Finance Charges

The Basics

Having some intelligence of how to calculate finance charges is constantly a good thing. Most lenders, as you know, will do this for you, but it can helpful to be able to check the math yourself. It is imperative, however, to comprehend that what is presented here is a elemental procedure for calculating finance charges and your lender may be using a more complicated method. There may as well be other problems attached with your loan which may affect the charges. The first thing to comprehend is that there are two elemental parts to a loan.

The first problem is called the principal. This is the amount of money that is borrowed. The lender wants to make a profit for his services (lending you the money) and this is called interest. There are a myriad of types of interest from simple to variable. This article will examine simple interest calculations. In simple interest deals, the amount of the interest (expressed as a percentage) does not difference over the life of the loan. This is many times called flat rate or fixed interest.

Samples

The simple interest formula is as follows: Interest = Principal × Rate × Time

Interest is the total amount of interest paid. Principal is the amount lent or borrowed. Rate is the percentage of the principal charged as interest each year. To do your math, the rate have got to be expressed as a decimal, so percentages have got to be divided by 100. For example, if the rate is 18%, then use 18/100 or 0.18 in the formula. Time is the time in years of the loan.

The simple interest formula is many times abbreviated: I = P R T

Simple interest math issues can be used for borrowing or for lending. The same formulas are used in both cases. When money is borrowed, the total amount to be paid back equals the principal borrowed plus the interest charge: Total repayments = principal + interest Usually the money is paid back in traditional installments, either monthly or weekly. To calculate the traditional payment amount, you divide the total amount to be repaid by the number of months (or weeks) of the loan. To convert the loan period, 'T', from years to months, you multiply it by 12. To convert 'T' to weeks, you multiply by 52, since there are 52 weeks in a year. Here is an example issue to illustrate how this works. 

Example:

A single mother purchases a used car by obtaining a simple interest loan. The car costs $1500, and the interest rate that she is being charged on the loan is 12%. The car loan is to be paid back in weekly installments over a period of 2 years. Here is how you answer these questions:

1. What is the amount of interest paid over the 2 years?

2. What is the total amount to be paid back?

3. What is the weekly payment amount?

You were given: principal: 'P' = $1500, interest rate: 'R' = 12% = 0.12, repayment time: 'T' = 2 years.

Step 1: Find the amount of interest paid. Interest: 'I' = PRT = 1500 × 0.12 × 2 = $360

Step 2: Find the total amount to be paid back. Total repayments = principal + interest = $1500 + $360 = $1860

Step 3: Calculate the weekly payment amount. Weekly payment amount = total repayments divided by loan period, T, in weeks. In this case, $1860 divided by 104 weeks equals $17.88 per week.

Calculating simple finance charges is easy once you have done some practice with the formulas.