Shannon Terrell
Barry Choi
Beth Buczynski
Credit cards are part of daily life for many Canadians. You can use them to make purchases, and they can help you build credit and earn rewards.
Credit cards are a convenient financial tool but can land you in debt if used irresponsibly.
Understanding how credit cards work and what options are available to you will help you take control of your finances.
How credit cards work
A credit card is a piece of plastic or metal issued by financial institutions to approved consumers looking for a line of credit.
Your credit card is assigned a credit limit, which is the maximum amount of money you can use to pay for goods or services. You’re essentially borrowing funds that must be repaid at a later date.
The exact rules governing how a particular credit card works, including limits, interest rates and fees, are found in its terms and conditions document.
Credit card providers will also report your credit history to one of the two credit bureaus: Equifax and TransUnion. If you make your payments on time, using a credit card can improve or maintain your credit score. Missing payments or maxing out your credit cards — spending all the way up to your credit limit — can negatively affect your credit score. A lower credit score might affect your ability to access other types of credit, such as a car loan or mortgage, in the future.
How credit card payments work
Credit card statements are issued at the end of each billing cycle, which typically lasts a month. Statements include a list of monthly transactions and how much money must be repaid: the balance owing.
When your bill arrives, you can pay the full balance, the minimum payment, or an amount in between. If you opt for the minimum payment or even a partial payment, you’ll incur interest charges. These extra fees can add up quickly and will increase the overall cost of your purchases.
How credit card interest works
Each time you use your credit card, you must pay back the borrowed amount plus interest. This interest is also called the annual percentage rate, or APR. The average rate for a Canadian credit card is 19.4%, according to NerdWallet analysis.
Some credit card companies offer an interest-free grace period for purchases. These grace periods typically last 21 days. Grace periods begin on the last day of your monthly billing cycle. You won’t owe any interest if you pay your balance in full before the next billing due date.
Credit card payment example
Say you use your credit card to book a $500 flight. It’s the only thing you charge to your card that month, and you don’t have an outstanding balance. Before your next billing period begins, you make a $50 payment to your credit card. You start your next billing period with a $450 balance, which now begins to accumulate interest at a rate of 19% APR.
If no additional payment is made within the next 30 days, the $450 balance will generate $7.08 of interest over the statement period.
» MORE: How is credit card interest calculated?
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4 credit card fees to watch out for
Every credit card charges fees, but they’re not always easy to spot. Here’s what to look out for:
1. Annual fees
Many credit cards charge a yearly fee. Cards with better rewards typically have higher fees. Some credit card fees are charged monthly instead of annually.
2. Interest charges
Every credit card has an interest rate for purchases and cash advances, and the rates for these two types of transactions may differ. Make sure you know these rates before you apply for a card.
3. Balance transfer fees
Some credit cards that offer balance transfers charge fees. In most cases, these fees are around 1% to 3%.
4. Foreign transaction fee
Many credit cards in Canada charge a foreign transaction fee of 2.5% on any purchase that’s not made in Canadian dollars. However, you may be able to avoid paying foreign exchange or transaction fees if you get an international credit card.
Credit card versus debit card
A debit card lets you make purchases with the funds available in your chequing account. You don’t pay interest on your purchases and your credit history isn’t impacted by what you spend.
A credit card lets you borrow money from a financial institution up to a certain limit. Whatever you borrow must be repaid with interest. The way you use your credit card can impact your credit score because your card issuer reports your payment history to the credit bureaus.
| Credit card | Debit card | |
|---|---|---|
| Spending limit | Borrowing limit set by the card provider. | Spending is limited to funds available in a chequing account. |
| Contributes to credit history | Typically. | No. |
| Annual fee | Sometimes. | Debit cards typically come free with a chequing account, though there may be annual fees associated with the chequing account. |
| Interest charges | Accrues interest on overdue balances. | None. |
| Insurance coverage | Common. | None. |
| Earns rewards | Common. | Less common. |
How credit cards build credit
Credit card providers report cardholder activity to Canada’s two major credit bureaus: Equifax and TransUnion. Credit card activity affects your credit score, but isn’t the only factor.
Lots of financial activity contributes to your credit score, including your debt repayment history, how much available credit you use, the age of your credit accounts and other financial events, like credit inquiries, bankruptcy and accounts sent to collections agencies.
Note that an overpaid credit card, one that has a negative balance does not have a negative impact on your credit score.
Types of credit cards
Although all credit cards work in similar ways, different credit cards offer different benefits and rewards. What kind of credit card you should pick depends on your needs, your credit, and other factors.
Rewards credit cards
If you have a good credit score (generally 660 and above), rewards credit cards may be appealing as you’ll get something back for every purchase you make. However, make sure the rewards you earn outweigh any costs you pay for the card, like an annual fee. Generally speaking, there are four kinds of rewards cards to consider.
Cash back cards
Cash back credit cards pay you back a fixed percentage of what you spend. Pay close attention to the payout details, as you could receive rewards monthly, yearly, or when you’ve earned a minimum amount of cash back.
Airline or hotel cards
Airline and hotel credit cards are suitable for people who like to travel and participate in specific loyalty programs. The points you earn may be used for free flights or nights at hotels.
General travel cards
Instead of being loyal to one specific brand, you can get a general travel credit card. Travel rewards programs tend to have more flexible redemption options but may not offer as much value as airline or hotel rewards.
Store credit cards
Many stores have their own credit cards that allow you to earn points from the retailer’s rewards program. These cards can be appealing, but the benefits have a limited scope. Make sure it is a good fit for your shopping habits before applying.
Most credit card purchases are assigned merchant category codes (MCCs) that can impact the points or cash back you earn. So it doesn’t hurt to check your statements to review the rewards earned on your monthly purchases and how your card categorizes spending.
Low-interest credit cards
As the name implies, low-interest credit cards have low interest rates, often in the range of 9% to 13%. Their rates can be significantly lower than the typical credit card interest rate of 20%, which can be an advantage if you carry a balance on your credit card. Some low-interest credit cards offer a balance transfer option with a promotional rate. This type of promotion allows you to move your debt from an existing credit card to your new one at a lower interest rate for a fixed period.
Credit cards for no/bad credit
If you don’t have a credit history or you’ve made mistakes that have lowered your credit score, you may not qualify for a traditional credit card. If that’s the case, you may want to consider a secured or prepaid card.
Secured cards
To qualify for a secured credit card, you’ll deposit security funds. The amount you deposit usually determines your credit limit. As you make purchases and pay off your balance, your history will be reported to one of the credit bureaus, and eventually, you may qualify for an unsecured credit card.
Prepaid cards
Prepaid cards are a practical option for those who want to limit their spending or who may not qualify for a credit card. These cards only offer access to funds added to the card’s account — similar to a debit card. Only a few prepaid credit cards report to the credit bureaus, though, so choose wisely if you hope to build your credit.
How to compare credit cards
The right credit card for you will depend on your spending habits and lifestyle. When selecting a card, consider the following:
- Annual fee. Cards with higher annual fees may offer more enticing perks, but the annual cost may not be worth it, depending on how you use your card.
- Interest rate. If you tend to carry a balance on your credit card, seek one with a lower interest rate.
- Rewards program. Rewards points and programs come in all shapes and forms. Look for a card with rewards that will incentivize you to make the most of the program.
- Balance transfer rate. If you intend to transfer an existing credit card balance to your new card, see if you can snag a 0% balance transfer offer. Some cards charge 0% interest for an introductory period when you transfer an existing balance.
- Eligibility criteria. Before you submit an application, review any minimum credit scores, annual income or annual spending criteria.
Credit card benefits and risks
Benefits
- Credit building. Credit cards can help you build a better credit score, which is vital for many situations in which you need to borrow money.
- Sign-up bonuses. Many cards offer a generous bonus when you’re approved, such as increased cash back or additional rewards points.
- Additional benefits. Depending on the card, you might get other perks such as travel insurance, extended warranty coverage, lounge access, and more.
- Flexibility. Credit cards can help you manage your monthly budget or even save you from a financial emergency — as long as you use them responsibly.
Risks
- Increasing your debt. Borrowing money to make purchases can be a slippery slope — especially if you don’t pay off the entire balance of your credit card on a regular basis. Carrying a balance means you’ll accumulate interest charges on what you owe, increasing the amount you need to repay in the long run.
- Harming your credit score. Missing a credit card payment can hurt your credit score. This, in turn, can affect your ability to apply for future loans and may impact the interest rate you may be offered as a result.
A credit card is a tool you can use on your financial journey. If you always pay off your balance in full, you can reap the benefits without paying extra costs.
However, you could fall into a debt trap if you overspend or fall behind on your monthly payments. Be smart about your money and use your credit card responsibly.
6 highly effective credit card habits
New to credit cards? Avoid beginner credit card mistakes by practicing these four habits of successful card use:
- Compare your credit card options. There’s no shortage of credit card options on the market, so select your card with care and intention. Reflect on your spending habits and financial situation to get a credit card that compliments your lifestyle.
- Unlock introductory offers. Many credit cards come with a welcome bonus of rewards points or cash back for new cardholders. To redeem the offer, you must typically meet a spending threshold within a certain amount of time.
- Aim to pay in full. By paying your credit card balance in full, the money you’ve borrowed won’t generate interest — saving you money in the long run.
- Maximize earn rates. Credit cards that earn rewards may offer a higher reward rate for money spent in different spending categories. Use your credit card strategically to maximize earned rewards.
- Automate your payments. If you can’t regularly pay your credit card balance in full, consider opting into automatic minimum payments. You can always make bigger payments as your finances allow, but minimum payments will keep your card in good standing and help you avoid late fees and penalty APRs.
- Avoid maxing out your card. Spending up to your credit limit could negatively impact your credit score. Financial experts suggest using no more than 35% of your available credit to avoid damaging your creditworthiness.
Frequently asked questions about how credit cards work
Yes. You can avoid paying credit card interest by paying off your balance in full each month.
When you request a credit card refund, the merchant that conducted the transaction will reverse the charge and the refunded amount is posted to your credit card. Refunds typically take three to five days to process.
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