Consumer Compliance Outlook: First Issue 2017

Understanding Finance Charges for Closed-End Credit

By Leslie A. Frogge, Former Examiner, Federal Reserve Bank of St. Louis

“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.” Regulation Z, 12 C.F.R. §1026.4(a)

The Truth in Lending Act (TILA) requires creditors to disclose key information about consumer credit transactions “so that the consumer will be able to compare more readily the various credit terms available” and “avoid the uninformed use of credit. …”1 The finance charge disclosure informs consumers about the cost of credit expressed as a dollar amount.2 It is also used in calculating other TILA disclosures, including the annual percentage rate (APR). Accurately computing and disclosing the finance charge is important because consumers may rely on it as well as related disclosures whose calculations are based on it, particularly the APR, when shopping for credit and evaluating credit offers. In addition, inaccurate finance charge and APR disclosures can result in restitution to the consumer if the errors exceed regulatory tolerances and can trigger the right of rescission in mortgage transactions subject to rescission.3

Despite the importance of the finance charge disclosure, violations continue to be frequently cited during Federal Reserve examinations.4 To facilitate compliance, this article reviews the regulation’s requirements for determining when a charge must be included in the finance charge, identifies common pitfalls, and offers tips and tools to assist lenders with avoiding and detecting finance charge violations.

Although the definition of a finance charge disclosure is the same for closed- and open-end credit transactions, the disclosure rules are different. This article will focus solely on the disclosure of finance charges for closed-end credit transactions, which are among the violations most frequently cited. The intent of this article is not to provide an exhaustive list of charges qualifying as finance charges under Regulation Z but to review the general principles for determining when a charge is a finance charge for closed-end credit.


Section 1026.4(a) of Regulation Z defines a finance charge as “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.”

While on its face this definition seems clear, it can be challenging to apply because of the wide range of fees and charges that can be incurred in credit transactions and because the definition is subject to several exceptions.

Table 1 displays the “Interagency Examination Procedures for Regulation Z,” which lenders may find helpful for identifying finance charges. That said, the chart and this article are instructive but meant only as a guide. Neither is exhaustive nor exclusive, nor does either substitute for the regulation or Official Staff Commentary (commentary). The chart categorizes charges into several categories: 1) some charges that are always included in the finance charge, 2) some that are always excluded, 3) some that may be excluded if certain conditions are met, and 4) some that are excluded with respect to credit secured by real property or in a residential mortgage transaction (even though they would be considered finance charges in other types of credit transactions). We use this framework for thinking about how charges should be included in the finance charge and when to exclude them.

Table 1


Charges Always Included

A key aspect of the finance charge definition quoted previously is that it captures charges borrowers incur only when they are financing their purchase instead of paying cash.5 Interest is the most obvious example and most common finance charge. Other charges that always qualify include, but are not limited to:

Charges Never Included

Regulation Z and the commentary provide examples of charges that are never finance charges because they are not incident to, or a condition of, an extension of credit, or because they are imposed uniformly on credit and cash transactions:

Charges Included Unless Conditions Met

In three different categories — third-party fees, insurance premiums and fees for debt cancellation/debt suspension coverage, and security interest fees — charges are included in the finance charge unless certain conditions are satisfied.


In some credit transactions, particularly secured ones, consumers may incur charges for services provided by third parties, such as a courier service, that are not otherwise payable in a comparable cash transaction. The regulation generally includes these third-party charges in the finance charge (when not expressly excluded elsewhere), if the creditor either:

If neither of these conditions apply, the third-party charges may be excluded from the finance charge.

A separate rule applies for charges by a third-party closing agent (such as a settlement agent, attorney, or escrow or title company). These charges are included in the finance charge if the creditor: 1) requires the particular service for which the fee is incurred, 2) requires the charge be imposed, or 3) retains a portion of the charge (if a portion is retained, that portion is a finance charge).20 Similar to the third-party charges described previously, if none of these circumstances apply, the charge may be excluded from the finance charge. Comment 4(a)(2)-1 of the commentary to Regulation Z provides as an example that a courier fee would be included when the creditor requires the use of a courier. (See also the discussion about lump sum closing charges.)

Special Rule for Borrower-Paid Mortgage Broker Fees

Borrower-paid mortgage broker fees are finance charges even if the creditor does not require the consumer to use the broker and does not retain any portion of the charge.21


In the case of a charge on premiums for certain types of voluntary insurance, such as credit life, accident, health, and loss-of-income, and premiums charged for voluntary debt cancellation or suspension coverage (whether or not the coverage is considered insurance), the charge may be excluded from the finance charge if the following conditions are satisfied:

Property insurance premiums may also be excluded from the finance charge if the consumer can choose the insurer and this option is disclosed.23 Additional disclosures regarding premiums and the terms of insurance are required if the insurance is obtained from or through the creditor.24

These same rules apply to a vendor’s single interest (VSI) insurance but only if the VSI insurer waives all rights of subrogation against the consumer.25


The following charges incurred for a security interest in the collateral securing a loan may also be excluded from the finance charge if the charges are itemized and disclosed:

Real Estate-Related Fees

Regulation Z applies a special rule that excludes five types of charges from the finance charge in a residential mortgage transaction27 or a real estate-secured loan, provided the charges are both bonafide and reasonable:

As noted in the commentary, these fees are excluded from the finance charge even if the creditor’s employees, rather than a third party, perform the services for which the fees are imposed.29 The cost of verifying or confirming information connected to an excludable item is also excludable. For example, credit-report fees cover not only the cost of the report but also the cost of verifying information in the report.30

When a lump sum is charged for several services, any portion attributable to a nonexcludable charge should be allocated to that service and included in the finance charge. However, the staff commentary notes that if a lump sum is charged for conducting or attending a closing and the charge is primarily for services related to items listed in §1026.4(c)(7), the entire charge is excluded even if a fee for incidental services provided (such as explaining various documents or disbursing funds for the parties) would be a finance charge if it were imposed separately.31

Finally, the charges under §1026.4(c)(7) for consumer loans secured by real estate and residential mortgage transactions are excludable only when imposed solely in connection with the initial decision to grant credit. For example, as noted previously, a fee for one or more determinations during the loan term of the current tax-lien status or flood-insurance requirements is a finance charge, regardless of whether the fee is imposed at closing or when the service is performed.

The commentary states the entire fee may be treated as a finance charge if a creditor is uncertain about what portion of a fee paid at consummation or loan closing is related to the initial decision to grant credit.32


Finance Charge Disclosure in Closed-End Transactions

While this article focuses on identifying and disclosing the finance charge, it is important to recognize that errors in determining the finance charge can contribute to errors in other TILA disclosures that rely upon an accurate finance charge.

In any closed-end credit transaction, TILA requires disclosure of the total finance charge, which is the sum of all charges, expressed as a dollar amount, that meet the regulatory definition of finance charge. For consumer closed-end real-estate secured loans (i.e., loans subject to the CFPB’s TILA-RESPA integrated disclosure rule that went into effect in October 2015), the finance charge must be disclosed on page 5 of the “Closing Disclosure,” as required by §1026.38(o)(2). For other closed-end loans, §1026.18(d) provides for disclosure of the finance charge, using that term, and a brief description such as “the dollar amount the credit will cost you.” The APR is also calculated based on the finance charge. Excluding charges from the finance charge that should have been included will result in an understated APR, which makes the APR appear lower than it actually is.

Regulatory Tolerances

Regulation Z defines tolerances with respect to the disclosed finance charge. For closed-end loans, the tolerances appear in Section 1026.18(d).

Mortgage loans:33

Other credit:

Inaccurate disclosure of the finance charge and APR outside of tolerances can result in restitution to consumers affected by such errors.


Common Issues

Properly classifying fees as finance charges can be challenging, and errors can be costly. Common issues Federal Reserve examiners have seen that result in finance charge errors include:

Tips and Tools

Creditors can employ a number of techniques to prevent finance charge violations, including the following:


Although the definition and treatment of finance charges have not changed in recent years, finance charge errors for closed-end loans remain a source of frequent violations and can result in restitution to affected borrowers. By taking a step back and looking at the charges using a methodical process, creditors can enhance controls to mitigate potential risk. Ensuring that staff is appropriately trained and that disclosure systems are up to date and accurate will help prevent disclosure errors. Routine testing processes will allow creditors to detect and correct any errors. Specific issues and questions should be raised with your primary regulator.


1 15 U.S.C. §1601

2 12 C.F.R. §1026.4(a)

3 15 U.S.C. §1607(e) (restitution); 12 C.F.R. §1026.23(a)(3)(i) and (ii) (the finance charge and the APR are two material disclosures that trigger right of rescission for up to three years after consummation if they are inaccurate).

4 The Federal Reserve Board examines state-chartered banks that are members of the Federal Reserve System with assets of $10 billion or less to ensure compliance with federal consumer protection laws, including Regulation Z. As of February 2017, the number of such banks was 830.

5 12 C.F.R. §1026.4(a)

6 12 C.F.R. §1026.4(b)(3)

7 12 C.F.R. §1026.4(a)(3)

8 12 C.F.R. §1026.4(b)(2)

9 12 C.F.R. §1026.4(b)(9). The commentary provides this example: A tract of land is sold for $9,000 if paid in cash, but $10,000 if financed. The $1,000 difference is a finance charge if the purchase is financed. Comment 4(b)(9)-1.

10 12 C.F.R. §1026.4(b)(3)

11 12 C.F.R. §1026.4(b)(5)

12 Comment 4(a)-1.ii.A External Link

13 12 C.F.R. § 1026.4(c)(7) and Comment 4(c)(7)-3

14 12 C.F.R. §1026.4(c)(2)

15 Comment 4(a)-1.i.A

16 Comment 4(a)-5.i.A

17 Comment 4(a)-1.iii

18 Comment 4(a)-1.ii.C

19 12 C.F.R. §1026.4(a)(1)

20 12 C.F.R. §1026.4(a)(2)

21 12 C.F.R. §1026.4(a)(3)

22 12 C.F.R. §1026.4(d)(1) and (d)(3)

23 12 C.F.R. §1026.4(d)(2)

24 12 C.F.R. §1026.4(d)(2)(ii)

25 12 C.F.R. §1026.4(d)(2)

26 12 C.F.R. §1026.4(e)

27 This is defined in §1026.2(a)(24) PDF External Link as a credit transaction secured by the consumer’s principal dwelling to finance the purchase or initial construction of the dwelling.

28 12 C.F.R. §1026.4(c)(7)

29 Comment 4(c)(7)-1

30 Comment 4(c)(7)-1

31 Comment 4(c)(7)-2

32 Comment 4(c)(7)-3

33 These tolerances apply to loans secured by real property or a dwelling. These same tolerances apply to loans secured by real property subject to §1026.38 as set forth in §1026.38(o)(2)PDF External Link