How to Calculate the Finance Charge on the Amount of a Loan

Finance charges on a loan can be calculated if you know the terms and conditions of the loan. The longer the term of the loan, the more you pay in finance charges at a given interest rate. The interest rate is another factor in determining finance charges. Finance charges are calculated based on the unpaid balance. The faster the balance is reduced, the less you pay in total finance charges. Having good credit helps ensure you receive a lower rate of interest.

Gather the Necessary Information

Obtain the terms and conditions of your loan, including the principal balance, interest rate and length of the loan. A loan with a principal balance of $35,000, an interest rate of 8 percent, a loan term of 120 months and a monthly payment of $424.65 will be used here as an example.

Determine the Finance Charges

Calculate the finance charges for the first month by multiplying the annual percentage rate of 8 percent (.08) by the balance of $35,000. Divide the result ($2,800) by the number of months in a year (12). That produces the finance charges for the first month, which is $233.33.

To determine the first month's principal payment subtract the finance chanrge of $233.33 from the monthly payment of $424.65. The resulting $191.32 is the principal balance payment, which is the amount the initial loan is reduced after one month. The remaining loan balance would be $34,808.68.

Follow the Formula

To calculate the finance charges for the second month, when the balance in our example would be reduced to $34,808.68 ($35,000 minus $191.32 in principal payment), use the same formula used above, substituting the new balance.

This calculation can be done every month with this formula, although it would be time consuming. The loan calculator can make this calculation for each of the 120 months. Notice that finance charges are reduced every month after a payment has been made, indicating that making principal payments greater than the minimum required will reduce the total finance charges.

Utilize an Online Calculator

Use an online loan calculator to determine the total finance charges for the life of the loan, assuming it is not paid off early. Enter loan terms, including balance ($35,000 in our example), length of loan (120 months in our example) and interest rate (8 percent in our example), into the calculator and hit the "Show/Recalculate Amortization Table" button. Finance charges will be automatically calculated and displayed. In our example, the total finance charges for the life of the loan will be $15,957.59.