What Is a Finance Charge on a Car Loan?

What Is a Finance Charge on a Car Loan?

The finance charge on a car loan represents the total cost of borrowing money, including any upfront fees and the interest paid throughout the life of the loan. These charges vary widely by lender and your specific loan agreement, but may include the following:

• Interest: Interest is the cost you pay your lender for borrowing money to purchase a car. Your lender calculates your car loan interest rate as a percentage of the loan amount, then spreads the charges over the life of your loan. The cost is baked into each monthly installment.
• Fees: Your lender may charge fees, such as origination fees, to cover the costs of processing your loan.
• Dealer fees: Dealerships may charge you for the costs of preparing the vehicle, such as the destination charge, document fee and inspection and emission fee. Some fees, such as fabric protection or paint protection, may be optional, but others are not.
• Government taxes and fees: Once you buy a car, you'll need to register it with your local government. The dealership often handles this for you and includes the costs in your finance charge. These may include the sales tax, title fee, licensing fee and registration fee—but they may vary based on where you live.

Tip: Lenders often express the finance charge as an annual percentage rate (APR), which can help you compare different loan options. Just be sure to understand which of the above costs are rolled into your loan.

Why Do Lenders Charge a Finance Charge?

Your lender and dealership may each levy fees and interest that collectively make up your finance charge. These charges provide compensation for processing the loan, extending credit to you, and preparing and registering the car. It also allows each party to earn a profit.

Lenders usually charge higher amounts to people they deem high-risk borrowers, such as those with lower credit scores, limited income and high debt-to-income ratios (DTIs). This helps offset some of the lender's loan risk.

Learn more: Hidden Costs of Getting an Auto Loan

How to Calculate Your Finance Charge

Auto loan calculators can tell you how much you'll pay on the full price of the loan, which typically includes interest, fees and taxes if you're financing through the dealer. Here's an example of how you can calculate the interest part of your finance charge:

Let's say you finance a vehicle for $25,000, including fees and taxes, with no down payment. You have a 7% interest rate, 60-month repayment term and $495 monthly payment.

Step 1:

Multiply your monthly payment ($495) by the total number of months (60) in your loan term.

• $495 x 60 = $29,700

Step 2:

Take the result and subtract the original principal from it.

• $29,700 - $25,000 = $4,700

The result is your finance charge, which is $4,700 in this example.

How to Lower Your Finance Charge

Depending on your specific loan agreement, the finance charge may be composed of several pieces. There are several ways to lower your finance charge, including:

• Negotiate lender fees. When you're shopping for car loans with different lenders, ask for a list of finance charges. Compare offers and ask if any lenders are willing to waive or reduce the fees. You can also negotiate features like the interest rate and prepayment penalties.
• Check your lending disclosure. If you've negotiated any loan details with your lender, ask for your Truth-in-Lending disclosure before you receive the contract. Make sure the disclosure reflects what you've agreed to.
• Improve your credit score. Lenders charge interest and fees, in part, to reduce the risk of lending to you. Improving your credit scores helps lower the lender's risk, so it may also reduce the APR and charges you pay.
• Go through a credit union. Getting a car loan from a credit union may be a good option for people who are just starting to establish credit, or who are rebuilding from a financial setback. Credit unions also typically offer lower APRs on average.
• Borrow a manageable amount. Making a larger down payment and buying a less expensive car are just two ways you can shrink your loan amount. This results in lower interest costs and potentially lower finance charges.
• Cancel optional add-on charges. Your dealer may offer additional products like extended warranties, gap insurance or debt cancellation programs. Negotiating these can help lower what you pay—and a flat-out "no thanks" will help you save even more.
• Choose a shorter loan term. Having fewer installments reduces your interest costs over the life of the loan. The shorter loan term may also help you qualify for a lower interest rate, since there is less risk of default over a shorter loan period.

Learn more: Car Loan Key Terms You Should Know

The Bottom Line

A car loan finance charge includes any upfront fees the lender and/or dealer charge plus interest you pay over the life of the loan. Understanding what's included in a finance charge can help you figure out whether you can lower the loan cost. Ask your lender for a list of fees you're paying, and try to negotiate where you can.