How Do I Calculate Finance Charges?

Having some knowledge of how
to calculate finance charges is
always 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 important,
however, to understand that
what is presented here is a basic
procedure for calculating
finance charges and your lender
may be using a more
complicated method. There may
also be other issues attached
with your loan which may affect
the charges.
The first thing to understand is
that there are two basic parts to
a loan. The first issue 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 many 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 change over the life of
the loan. This is often called flat
rate or fixed interest.
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 must
be expressed as a decimal, so
percentages must 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
often abbreviated:
I = P R T
Simple interest math problems
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 regular installments, either
monthly or weekly. To calculate
the regular 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 problem 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.