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How Does Credit Card Interest Work in Canada?

The Borrowell Team

Dec 14, 2023 5 min read

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How do credit cards work

Navigating the world of personal finance involves understanding important concepts, and one such crucial aspect is how credit card interest works.

In this guide, we'll break down the complexities of credit card interest rates in Canada, making it easy to grasp. We'll explore what influences these rates and share practical tips to help you manage your credit wisely. Let's dive in and make sense of how credit card interest affects your financial journey.

Basics of Credit Card Interest

To grasp the concept of credit card interest, it's essential to understand the fundamentals. Credit card interest is the cost of borrowing money from the credit card issuer. In Canada, credit card interest rates are typically expressed as an annual percentage rate (APR), representing the total cost of borrowing over a year.

Let's take a look at the different types of credit card interest:

  • Purchase APR: This is the interest applied to the outstanding balance on purchases made using the credit card.

  • Cash Advance APR: When you withdraw cash using your credit card, a different, usually higher, interest rate known as cash advance APR comes into play.

  • Balance Transfer APR: Some credit cards offer the option to transfer balances from other cards at a lower interest rate for a limited, promotional period.

(Note that it's common in Canada for the same credit card to have different rates for the three different types of interest).

Factors Influencing Credit Card Interest Rates

Several factors contribute to the the credit card interest rates you'll be offered in Canada:

  • Your credit score: A higher credit score often leads to lower interest rates, as it signifies a lower risk for the lender.

  • Economic conditions: The overall economic climate can impact interest rates. For example, if the Bank of Canada decides to raise the key interest rate like they did in 2022 and 2023, credit card issuers may adjust rates accordingly

  • Credit card type: Different credit cards come with varying interest rates. Rewards cards, for instance, may have higher rates than basic or secured cards.

How Does Credit Card Interest Work?

Understanding how interest is calculated is crucial for effective financial planning. You’ll pay interest if you don’t pay your credit card balance in full by the due date. You’ll continue to pay interest until you pay your balance back in full.

Interest-Free Grace Periods

Credit card issuers give a grace period to pay for your previous month’s purchases without interest. The grace period begins on the last day of your billing period. However, this grace period doesn’t apply to cash advances or balance transfers. On those transaction types, you'll start accruing interest right away.

If the bank or credit card issue is federally regulated, they are required to provide a 21-day interest-free grace period.

Let's look at an example: say you buy a new sweater using your credit card on March 15. On April 1, you get your March credit card statement which includes the sweater purchase. A 21-day interest-free grace period will apply to purchases made in March, so you have until April 21 to pay off the sweater and your other purchases in full before you'll start being charged interest.

If you don't repay the balance in full, you'll pay interest on the portion you haven't paid off.

Compounding Interest

If you don't pay off your balance in full before the end of the interest-free grace period, you'll start accruing interest. Credit card interest in Canada usually compounds daily, meaning that interest is calculated on the remaining balance each day. This compounding effect can significantly increase the overall cost of borrowing and can spiral quickly.

For this reason, we advise treating your credit card like a debit card, and only using it for purchases that you can afford to pay back at the end of each month.

Managing Credit Card Interest

To minimize the impact of credit card interest, borrowers can take proactive measures:

Paying in Full: The most effective way to avoid interest charges is to pay the credit card balance in full by the due date each month.

Negotiating a Lower Rate: In some cases, it may be possible to negotiate a lower interest rate with the credit card issuer, especially if you have a good payment history.

Using Low-Interest Cards: Consider using credit cards with lower interest rates, especially for carrying a balance.

How Does Using a Credit Card Affect Your Credit Score?

Beyond the financial implications, it's crucial to recognize how using a credit card can influence your credit score. Your credit score is a numerical representation of your creditworthiness, and credit card activity plays a significant role in shaping it.

  • Credit Utilization Ratio: One of the key factors affecting your credit score is the credit utilization ratio, which is the proportion of your available credit that you're using. High credit card balances relative to your credit limit can negatively impact your credit score. Aim to keep your credit utilization below 30% to demonstrate responsible credit management.

  • Payment History: Timely payments on your credit card contribute positively to your payment history, a major component of your credit score. Late payments, on the other hand, can have adverse effects. Set up automatic payments or reminders to ensure you pay your credit card bills on time.

  • Credit Mix: The variety of credit accounts you have, including credit cards, can influence your credit score. A well-managed mix of credit types, such as credit cards, loans, and mortgages, can positively impact your creditworthiness.

  • Length of Credit History: The age of your credit accounts matters. Keeping a credit card open for an extended period demonstrates a longer credit history, which can positively affect your credit score. Avoid closing old credit cards, as this can shorten your credit history.

  • New Credit Applications: Each time you apply for a new credit card, a hard inquiry is made on your credit report, potentially impacting your credit score. While the impact is usually minor, multiple inquiries within a short period can be a red flag to lenders.

Understanding these aspects of credit card usage and their impact on your credit score is essential for maintaining a healthy financial profile. By managing your credit responsibly, you not only save on interest costs but also contribute to the overall health and strength of your credit history and score.

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