Borrowing 101: Introduction to Credit Cards
Apr 27, 2020 • 4 min read
With all the different credit options available in Canada, it’s important to understand the differences between each so that you can find the right product for your needs and use credit responsibly. Credit cards can be useful to help you establish a good credit history and finance purchases, but should be used mindfully.
In this Borrowing 101, we’ll give you an overview of credit cards. Stay tuned for other content in this series on personal loans, lines of credit, and mortgages to help you understand how they work, when to use them, and what to be careful of.
How do Credit Cards Work?
A credit card is a fixed amount of money that you’re given access to by a lender. You can charge as much as you want to your credit card at any given time, up to your limit, and if you pay it off in full each month, you’re not charged interest. If you’re unable to pay off your credit card in full you’ll be charged interest on any outstanding balance.
Interest rates are often high, often upwards of 19%, so outstanding balances can snowball and become unmanageable very quickly. You have to make at least the minimum payment each month in order to remain in good standing with your credit card issuer, avoid late fees, and not have your credit score impacted.
A credit card is considered a revolving loan which means that you’re able to reuse the loan over and over as long as you continue to pay back what you’ve borrowed. If your credit limit is $5,000 and you spent $1,000 this month and paid it all back, you’ll have access to that full $5,000 again. Most credit cards are unsecured lines of credit, meaning that the issuer extends you funds based on your credit history and doesn’t require you to put up collateral.
If you’re working to re-establish your credit after insolvency, then a secured credit card can be an excellent option. A secured credit card is kind of like a prepaid loan in that you give the lender a cheque for $1,000 and they in turn give you a card with $1,000 on it to spend.
Make sure you pay attention to your credit utilization which accounts for 30% of your credit score.
When is a Credit Card Useful?
Credit cards can be a good way to establish credit, which can help you access favourable rates for large loans down the line such as for a house or car. Plus, many cards offer perks, such as reward points, travel insurance, flight rewards, cash back, or no foreign transaction fees. There’s a huge variety of credit cards available in Canada with perks that are tailored to various lifestyles and needs.
You can find the best credit cards to match your profile and likelihood of approval by signing up for free or logging in to your account.
What to be Careful of
It’s only a good idea to get a credit card if you know you’re able to pay off the balance in full each month. It’s tempting to see a credit card as free money, but the high interest rates compound over time and can put you in a dangerous financial position. As a general rule of thumb, only charge something to a credit card if you know you have the cash to pay it off. Make a budget and stick to it. If you already have a high balance, you may want to look into debt consolidation.
You’ll also want to look carefully at the fees and terms associated with the card. Many credit card issuers offer promotional interest rates of 0% for a set length of time, but those rates go up after the promotional period ends and you’ll be charged interest retroactively on any outstanding balance. This can also be the case with balance transfers.
The Bottom Line
Before applying for any type of credit check your credit score and report and take the necessary steps to boost your credit health. Your payment history and credit score will determine what types of credit cards you qualify for, so it’s in your best interest to continuously monitor your financial situation.
Used wisely, credit can be a wonderful tool to help you achieve your lifestyle and financial goals.
Borrowell is dedicated to making financial stability possible for everyone. With over 1.5 million members, the company offers free credit scores in Canada, education, weekly credit monitoring, credit building solutions, as well as digital tools like AI-powered credit coaching and personalized financial product recommendations. For more information, visit borrowell.com or download the mobile app for Android or iOS.