Finance Charge Calculation

How is the finance charge figured out on the truth-in-lending disclosure statement?

1 Answer

Here's how you figure out the " Finance Charge" shown in the second big box from the left towards the top of the Truth-in-Lending disclosure:

Let's assume a $400,000 loan amount and $2,000 in applicable prepaid finance charges (more on prepaid finances in a bit).

The first step is to calculate the monthly payment for principal and interest only. The taxes and insurance that get collected by your mortgage company (if you have escrows) are part of your cost of owning the property, NOT part of the cost of financing it. If we use an interest rate of 6.25% for a 30-year fixed loan, you should get a monthly payment of $2,462.87. If mortgage insurance were required for the loan, the monthly amount would be added to the $2,462.87. If we multiply that number by 360 - the number of months in thirty years - we get $886,634.48. That is the total amount of money that will be paid to the lender over the course of thirty years.

The next step is to add the " pre-paid finance charges" to the $886,634.48. For the sake of this explanation, I said we would assume $2,000.00, so that gives us $888,634.48. In real life, we would need to add up the "pre-paid finance charges" that the borrower pays in connection with the loan. This term is defined in Regulation Z as:

The finance charge is the cost of consumer credit as a dollar amount. It includes any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit. It does not include any charge of a type payable in a comparable cash transaction.

Examples would be things like the lender's underwriting and processing fees, origination fees, broker fees, mortgage insurance, pre-paid interest charged if you close before the end of the month, and so on. On an accurately prepared Good Faith Estimate, the items marked with a check mark under the column labeled PFC are the ones considered to be pre-paid finance charges.

The last step is to subtract the loan amount from the total of the pre-paid finance charges and mortgage payments over the life of the loan. In this case we would get a figure of $448,634.48, which is the number that we'd find in the Finance Charge Box on the Truth-in-Lending Statement.