How Credit Card Interest Rates Work in Canada

If you have a credit card, you’ve likely thought about your interest rate, sometimes referred to as the annual percentage rate, or APR. In its simplest form, interest is a fee you pay for borrowing money.

A credit card may have different types of interest rates, such as purchase APR, balance transfer APR and cash advance APR. How much interest you’ll pay depends on how you use your card and the amount of your transactions. 

How does credit card interest work?

At the end of each billing cycle, your credit card issuer will charge interest on the card’s balance.  If you pay your balance in full every month, you won’t pay any interest charges. 

Example: If you spend $500 on your credit card and only pay back $100 at the end of the money, the issuer will charge you interest on the remaining $400 until it is paid off. However, if you pay the full $500 when the bill is due, no interest is charged.  

Credit card interest is calculated daily

If your credit card has an annual interest rate of 18%, it doesn’t mean you get charged 18% interest once a year. The 18% is divided by 365 (for each day in the year) and then multiplied by your average daily balance during the month.

While you can’t change your interest rate, you can lower your average daily balance by making multiple payments throughout the month. 

Example: Say you have a $2,000 balance and can pay $1,000 toward your credit card bill. If you pay $1,000 on the 20th day of a 30-day billing period, your average daily balance would be about $1,667. But if you pay $500 on day 10 and $500 on day 20, your average daily balance would be $1,500. The second strategy reduces your interest charge by about 10%.

Paying in full is the most cost-effective way to go, but if you usually carry a balance, try to pay your credit card bill twice a month, or more frequently, rather than once. That extra payment will shrink your average daily balance and, in turn, your interest charges. If you always carry a balance, consider a low-interest credit card can help you save more money on interest.

How do card issuers determine interest rates?

Some credit cards have a single purchase APR for all customers while others advertise a range and assign a specific rate based on your credit history. The better your credit score, the lower your rate. The rates and ranges themselves are set by the issuer and can vary among providers.

Interest rates can also vary based on the type of transaction you make — you might see 18% interest on regular purchases and 22% on balance transfers or cash advances.

The type of credit card can also influence the APR. Retail credit cards tend to come with higher interest rates, for example.

Types of credit card interest rates

If you’ve read your credit card’s terms and conditions, you’ve likely noticed different interest rates for different types of transactions. Here are some common types of credit card interest rates you’ll see on your statement.

Purchase interest rate

The most common interest rate associated with credit cards is the purchase rate. This is how much interest you’ll pay on everyday spending. Many Canadian credit cards have a purchase interest rate of around 20% but may be as high as 23%. The interest is not charged if you pay back the balance before the due date. 

You’ll typically get an interest-free grace period of at least 21 days after the end of your billing period to pay the balance. So, if your billing period ends on February 1st, you have until February 21st before interest is applied.

Credit cards charging lower purchase interest rates do exist in Canada, but they typically don’t come with many perks. Charge cards generally have the highest purchase interest rate, as they’re designed to be paid off in full each month.

Cash advance interest rate

Many credit cards allow you to withdraw money from ATMs. This is called a cash advance, and it comes with an interest rate that’s typically higher than the one applied to purchases. It’s worth noting that lottery ticket purchases, wire transfers and gambling site transactions are also considered cash advances.

Balance transfer interest rate

Balance transfer credit cards allow you to move your balance from one card to another. This can be handy for debt consolidation or to take advantage of a lower interest rate. When you move the debt, a balance transfer interest rate is applied to the funds on the new card. 

You may also be charged a fee when you transfer a balance — typically a percentage of the total amount or a flat fee, whichever is higher. This is separate from the interest rate.  

Promotional interest rates

Many low-interest credit cards offer a promotional interest rate for purchases or balance transfers. If you’re carrying a balance on a card with a higher interest rate, you can take advantage of a promotional rate to transfer your balance to a lower-interest card. For example, a card may offer 0% interest on balance transfers for 12 months (although you should also check for any extra fees). 

Penalty interest rates

Most credit cards apply a penalty or default interest rate if you have a history of missed payments. In most cases, you’ll be allowed to miss one payment without seeing your rates go up. However, if you miss two payments within a certain period, like 12 months, your interest rate may increase. You can avoid penalty interest rates by making at least the minimum payment each month.

How can I lower my credit card interest rate?

Interest rates are determined by the credit card provider and are non-negotiable. But while you can’t change the interest rate itself, you can take a few steps to reduce how much interest you pay:

• Always pay your bill in full. If there’s no balance, there’s nothing for the provider to charge interest on. If you can’t pay the whole bill, pay more than the minimum payment, to avoid late fees and damage to your credit.
• Don’t wait until your bill is due. Make payments throughout the month to reduce your average daily balance.
• Avoid cash advances and similar transactions, like buying lottery tickets and making wire transfers.
• Apply for a low-interest credit card.
• Take advantage of promotional interest rates and aim to pay off your credit card balance during the promotional period.

How to calculate credit card interest

While lenders use different methods, here’s a general overview of how interest is typically applied. If you want to follow along, grab your credit card billing statement.

1. Convert the annual rate to a daily rate

Your interest rate is identified on your statement as the annual interest rate (AIR) or annual percentage rate (APR).

Since interest is calculated on a daily basis, you’ll need to convert the annual rate to a daily rate. In most years, you’ll do that by dividing it by 365; if it’s a leap year, divide by 366. The result is called the periodic interest rate, or sometimes the daily periodic rate.

2. Determine your average daily balance

Your statement will tell you which days are included in the billing period. Your interest charge depends on your balance on each of those days.

Using the transaction information on your statement, go through the billing period, day by day, and write down each day’s balance. Hint: Using a spreadsheet will make the next step easier.

Once you’ve written down all your daily balances, add them up, and then divide the sum by the number of days in the billing period, such as 30. The result is your average daily balance.

3. Put it all together

The final step is to multiply your average daily balance by your daily interest rate, and then multiply that result by the number of days in the billing period.

Depending on whether your issuer compounds interest daily or monthly, the actual interest charge you see on your statement might differ slightly from the amount you calculated.

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