How Credit Card Interest Works

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credit card interest rates Credit card rewards and cash back perks are a great benefit to using your credit card for everyday spending, but it's important to remember that credit cards also charge you interest. But how credit card interest works exactly?

Credit card interest is the cost of borrowing money, and when you make purchases on your credit card, you are borrowing money temporarily from the credit card company. You have to pay that money back promptly – otherwise, you will be charged a percentage of your purchase value as interest.

It's important to understand credit card interest because interest charges cut into the rewards earned by using your credit card for everyday purchases. If you pay more in interest charges than you earn in rewards, your return on your spending will be negative – meaning you are actually worse off than you were before using your credit card.

Different Types of Credit Card Interest Rates

Several different interest rates apply to your credit card purchases, depending on the type of purchase and your payment history. All interest rates are calculated on an annual basis, which is why interest rates are often referred to as the annual percentage rate (or APR). Your APR is broken down and charged monthly on your outstanding balance.

There are several different interest rates listed in your credit card's terms and conditions beyond the APR. Understanding these terms will help you avoid any surprises with your credit card's interest.

Purchase Interest Rate Explained

This is the most common type of interest and is the interest rate charged on your credit card balance. Your credit card balance is the sum total of your purchases. Most Canadian credit cards have an interest rate of around 19.99%, although there are low-interest credit cards and balance transfer credit cards, which have lower purchase interest rates.

Your credit card's purchase interest rate is only applied on credit card purchases if you don't pay off your balance in full every month. Every purchase you charge to your credit card is subject to a grace period where it does not incur interest. Your credit card's grace period must be at least 21 days.

As long as you pay off your credit card before the 21-day grace period expires, you won't pay any interest on your purchases. The easiest way to ensure you never pay credit card interest charges is to pay off your credit card balance in full on your statement's due date.

If you are late in paying off your credit card, or you don't pay off the entire balance in full, you'll pay interest on your credit card charges starting from the day you made the purchase. The interest rate you'll pay is your credit card's APR, and it will show up as a monthly charge on your credit card statement.

Cash Advance Interest Rate

You can use your credit card for more than just purchases online or at retailers. You can also use your credit card to withdraw cash from an ATM using the cash advance option. A cash advance lets you withdraw money and charge the withdrawal to your credit card's balance. Some other purchases also fall under the cash advance umbrella, including wire transfers, money orders, traveller's cheques, and some lottery tickets.

Using your credit card's cash advance feature may seem like an excellent way to earn additional rewards or cash back, but there is a huge caveat that makes this an ineffective strategy. The interest rate for a cash advance is usually higher than your credit card's purchase interest rate.

Interest-Free “Grace Period” Explained

When you charge a purchase to your credit card, that purchase is subject to a grace period, which is a term where you will not be charged interest on your purchase. The minimum grace period length is 21 days.

The easiest way to make sure you don't go over your grace period is to pay down your balance in full on the day your credit card payment is due. If you don't pay down your balance in full, the grace period expires, and you will owe interest on your purchases starting from the day you made the purchase. The grace period still applies to new purchases, even if there is a balance carried forward from the previous month.

Other Interest Rates

Your credit card's purchase interest rate and cash advance interest rates aren't the only interest rates that might apply to your credit card activities.

A standard interest rate is the balance transfer interest rate. Some credit cards offer a low promotional interest rate (usually between 0% – 5%) when you transfer a balance from another credit card. This interest rate only applies to the transferred balance and usually expires after a period like six months. These interest rates are very low and can be an excellent way to pay off your debt quickly.

It's essential to pay off your transferred balance before the promotional interest expires because after it ends, your transferred balance will be subject to your credit card's regular purchase interest rate.

Finally, if you transfer some of your unused credit card balance to pay off another credit card, this transfer will be subject to a special balance transfer rate that is usually the same as the cash advance interest rate.

Our favourite balance transfer card is MBNA True Line® Mastercard®* because of its amazing balance transfer promo: pay 0% interest for the first 10 months on balance transfers completed within 90 days of account opening, with 3% transfer fee (min. of $7.50). This card also has no annual fee and an annual purchase interest rate of 12.99%, which even applies on balances remaining after the promotional period expires or if you miss a payment. *This offer is not available for residents of Quebec. For Quebec residents, please click here.

Variable Interest Rates Cards

Some credit cards offer a variable interest rate that is tied to Canada's prime rate. When the Bank of Canada raises or lowers the prime rate, your credit card's interest rate will increase or decrease accordingly. Usually, these credit cards have an interest rate that is expressed as “prime + X%.” The rate you'll secure with a variable interest rate credit card depends on many factors including your credit score, your income, and your employment history, so if you are considering applying for a variable rate credit card, it's essential to shop around.

For variable interest rate cards, TD Emerald Flex Rate Visa* is one of the best of the bunch. This card offers a variable purchase interest rate that ranges from TD Prime + 4.50% up to TD Prime + 12.75%, but what you pay depends on your credit assessment. If you have a very good credit score, you will likely qualify for a purchase interest rate as low as TD Prime + 4.50%. Since TD’s Prime Rate is currently 3.95%, that means you could have an interest rate as low as 8.45% — that' s rock bottom in the credit card world.

Card Details:

Annual Fee: $25
Purchase APR: TD Prime + 4.50% up to TD Prime + 12.75%
Cash Advance APR: TD Prime + 4.50% up to TD Prime + 12.75%

Learn more about the TD Emerald Flex Rate Visa*.

*This offer is not available for residents of Quebec. For Quebec residents, please click here.

Fixed Interest Rates

While variable-rate credit cards exist in Canada, the vast majority of the best credit cards in Canada, especially travel reward cards or cash back credit cards, have a fixed interest rate. A fixed interest rate means that the interest you are charged on your purchases, cash advances, and balance transfers does not fluctuate. There is one exception to this rule: penalty interest rates.

Penalty Interest Rates

If you don't make your monthly payments on time, your credit card provider may charge you a penalty interest rate that is higher than your standard purchase interest rate. Usually, you can miss one payment, but if you miss more than one, your lender will raise your interest rate.

You can find out exactly how high your penalty interest rate is by reading your credit card agreement, but it can be as high as 30%. If you incur a penalty interest rate, you'll have to be diligent about making your monthly payments on time, and eventually, your lender will lower your interest rate back to normal levels.

The easiest way to deal with a penalty interest rate is to avoid it in the first place by never missing a monthly payment. If you can't pay off your balance in full every month, at least make your minimum monthly payment to avoid penalties.

What is the “Minimum Payment?”

Every month, you'll receive a credit card statement, either in the mail or online, that tallies up your purchases for that statement period. Your credit card statement will also include your total balance and the minimum payment that you'll need to make to keep your credit card in good standing.

Your credit card statement's minimum payment is the smallest payment you must make to avoid penalty interest rates and damage to your credit score. For these reasons, it is imperative that you pay at least the minimum on your credit card statement every month, even if you don't have enough money to pay off the balance in full. Bear in mind, each credit card provider calculates its minimum payment differently.

For example, the Tangerine Money-Back Credit Card calculates your minimum payment as the total of $10 plus interest, fees, any amount over the credit limit, and any amount past due as of the statement date; meanwhile, other credit cards may calculate theirs differently. You can find the exact method of calculation in your cardholder agreement.

Your minimum payment is the smallest monthly payment that you must make, but it doesn't pay off the balance entirely. The remaining balance will now be subject to the credit card's purchase interest, which can result in hundreds of interest charges every month.

The bottom line? If you only make the minimum payment on your credit card, it will take years to pay off your credit card in full. For example, if you have a credit card with a $1,000 balance at 18% interest, and you only make the minimum monthly payment of 3% of the balance or $10 (whichever is greater), it will take you 10 years to pay off your credit card, and you'll pay $798.89 in interest charges in the process.

If you keep adding new charges to your credit card balance, you may never pay off your balance at that rate. For this reason, it's crucial to make every effort to make more than the minimum monthly payment.

When to Look for Lowest Interest Rate Credit Card

If you have a credit card balance that you are looking to pay off, or you need to make a large purchase, but you don't have the cash on hand, you should look for a low-interest rate credit card. The lower interest rate will save you money while you pay back the balance. For a comprehensive look at the brands currently on the market, read our guide to the best low interest rate cards in Canada.

If you are confident you can pay off the balance in a short period, such as six months, a balance transfer credit card may be an excellent way to spend that money and pay zero interest – that is, as long as you pay off the balance before the promotional period ends. To help you choose a card that’s best for you, read our head-to-head comparison for the best balance transfer credit cards in Canada.

If you are in the habit paying off your credit card every month, and you never miss a monthly payment, you should find a credit card that will best reward your spending habits with cash back or travel rewards.

Closing Words

Rewards credit cards and cash back credit cards can be a great way to profit from your daily spending, but only if you are diligent and pay your balance off every month. If you don’t, you’ll incur interest charges as high as 19.99%, or penalty interest charges that are even higher. These charges are enough to wipe out any rewards you’ve accrued on your spending, so it’s important to follow the tips above and avoid paying hundreds of dollars in easily avoidable interest charges. Above all, do your homework: read up on the best credit cards in Canada in 2019, and choose a credit card that best suits your lifestyle and financial situation.

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Jordann Brown

Jordann Brown is a millennial money expert and personal finance blogger based in Nova Scotia, Canada. Jordann is the founder of the popular personal finance blog, My Alternate Life, and she frequently appears as an expert in Canada media.

1 Comment

  1. Edward H C Graydon on June 9, 2019 at 12:46 am

    Agreeing then signing the original contract is where ones financial irresponsibility begins. It is the fact that one would enter into such a rate of interest that shows desperation and the need for credit at any cost regardless.
    I have found in my own dealings with unsecured credit that volume is king. The interest rates are deterrents for lenders and the real money made is from point of the sale income for the banks. Point of sale income is the money that the merchant pays on each transaction when you buy and that percentage varies from bank to bank but I have found in my own personal dealings that banks would rather have income flow from that side than the interest paid by the end user. The lowest rate of interest that I have negotiated for my own personal card issued by the bank of Montreal is 3.9 per cent for ten years. I can live with prime but it is hard to achieve. Banking for many is a game of challenge where actual materialism is not the end goal but the astuteness of the contractual agreement is the end game. I have never entered into a credit card agreement where the assigned rate of return is more than 3.9 per cent
    Regardless of rates, it is the principle that most people never are able to pay for they did not save they borrowed and ignored the ability of delayed gratification for instant, that now puts them in a ball and chain type relationship with the banks for the sake of materialism.



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