Future Business Leaders of America (FBLA) Personal Finance Practice Test

How is the finance charge on a loan or credit card typically calculated?

1. Using the total loan amount

2. Based on the payment history

3. Using the APR

4. Based on monthly income

The correct answer is: Using the APR

The finance charge on a loan or credit card is primarily calculated using the Annual Percentage Rate (APR), which represents the yearly cost of borrowing expressed as a percentage of the loan amount. The APR takes into account not only the interest but also any additional fees that may be associated with the loan, providing a comprehensive measure of the total cost of borrowing. When you multiply the outstanding balance by the APR and then adjust for the term of the loan (often converting it to a monthly rate), you can determine how much interest will be added as a finance charge. This method is standard across loans and credit cards, ensuring that borrowers have a clear understanding of how much they will owe over time. Other methods, such as assessing the total loan amount or focusing on payment history, do not provide a systematic approach to calculating charges in the same way that APR does. Monthly income is typically irrelevant in determining the finance charge itself, as it does not influence the cost of borrowing directly. Understanding the significance of APR is crucial for managing loans and credit effectively.