Finance Charge vs. APR: Understanding Loan Costs

Loans are often necessary to help cover unexpected expenses or to purchase particularly expensive items, such as cars and homes. When a consumer borrows money, he may not understand all the charges associated with the loan. Most lenders charge annual interest rates, or APRs. Lenders may also impose additional charges, which constitute finance charges.

Finance Charge vs. Annual Interest

Lenders want to provide some incentive to the borrower to repay the loan in a timely fashion. Finance charges and interest rates impose additional monetary obligations on the principal balance of the loan. Finance charges include all charges associated with the loan, including interest and commitment fees. The annual percentage rate is the amount of interest that compounds daily.

Usury Laws

Usury laws protect consumers from "predatory" lending. A usurious loan is one that charges an interest rate greater than that allowed by law. There is no federal usury limit. Usury limits also vary by state; not every state imposes a usury limit. State laws vary on the penalties for usurious loans. In general, the lender is not entitled to recover costs or interest on the judgment.

Usury and Finance Charges

In general, usury only applies to illegal interest rates. A lender in a state with a 12 percent usury rate may not charge an APR greater than 12 percent. However, the agreement between the lender and borrower may require the borrower to pay additional charges classified as finance charges. In total, the entire obligation may result in payments that technically exceed the usury rate. The loan is only usurious if the APR exceeds the state limit.

Other Issues

Usury laws have relatively limited application and, as of the date of publication, have several loopholes. Complications arise when lenders operate in multiple states. The law of the state where the business has its principal location governs the lender's behavior. A credit card company may incorporate in a state that has no usury limit. If that same company opened a branch in a different state, it could charge an otherwise illegal interest rate in that state, because the state of its principal location has no usury limit.