Credit cards 101: How do they work?

10 February 2023 by National Bank
Women looking at her credit card statement on a laptop

Do you really know how your credit card works? Interest calculations, minimum monthly payments, credit limits, annual fees… There are many things you need to know to get the most out of your credit card. These tips will help you use it the right way.

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What is the interest on a credit card?  

The interest rate charged on your purchases is calculated on an annual rate. To find out how much interest you will pay each day, divide it by 365 days. For example, if the interest rate is 20.99%, the daily rate is 0.0575%. 

How is interest calculated on a credit card? 

Calculating interest on your purchases 

If you pay your balance in full by the due date on your monthly statement, you won’t pay any interest on your purchases. Otherwise, interest will be charged starting from the transaction date and will be added to your next statement balance. 

For example: If you made a purchase 15 days ago, your daily interest rate applies to those 15 days; it doesn’t start on the due date to pay your balance. 

It’s important to keep in mind that even if you pay off part of the balance, you will still be charged interest on the total amount of your purchases until the balance is paid in full. The interest is always calculated from each transaction date.  

Calculating interest on cash advances 

Your credit card also allows you to withdraw money or make certain transactions such as bank transfers or cheques. These transactions are called cash advances. In this case, there is no grace period and interest begins to accrue starting from the transaction date and stops only once the amount is paid in full. 

Important! Cash advances generally have a higher interest rate. Check your credit card agreement for terms and conditions. 

Expert tip: Some credit cards charge lower rates. 

How do minimum payments and repayments work? 

If you are unable to pay off your credit card balance in full, you are still required to make a minimum monthly payment

For Canadian residents, excluding Quebec, it varies from bank to bank but is generally around 3% of the total balance. 

In Quebec, for credit cards issued after August 1, 2019, the minimum payment is 5% of the total balance (purchases, interest, fees, etc.) or $10, whichever is greater. For cards issued before that date, the percentage is 3.5% as of August 1, 2022, and will gradually increase by an additional 0.5% per year to 5% in 2025. 

Good habit: To avoid interest, pay off your entire balance – not just the minimum payment – by your monthly statement’s due date.  

What is a credit limit and how is it determined? 

Your limit is the maximum amount you can use on your credit card. It is set by your financial institution based on your credit history and other factors. Some cards have minimum credit limits. 

You can accept the maximum limit offered to you or choose a lower one. Consider these two factors when deciding what the right limit is for you: 

  1. Your credit score. Ideally, you should not use more than 30% to 35% of your available credit. If your balance climbs too high, say above 50%, it will have a negative impact on your credit rating. Keep in mind that your credit limit should be high enough to allow you to use your card comfortably while staying well below it.  
  2. Your finances. Your credit limit should respect your monthly budget. If it exceeds it, make sure you have the discipline to always pay off your balance. 

To find the right limit for you, choose an amount that represents the sweet spot between a limit that is high enough so you don’t get too close to it when you use your card and one that respects your capacity to pay. 

Expert tips

What impact can a credit card have on your credit file? 

Although a credit card is not essential to building a credit history, it does have a big impact on your credit score. When used responsibly, it will help you build and improve your credit score. However, it can also hurt it.  

To build a solid credit history and good credit score, always make your minimum payments on time and keep your balance at a reasonable level compared to your limit.  

Discover tips to build or rebuild your credit score.  

Learn more about credit scores

What are the annual fees for a credit card? 

Some credit cards charge an annual fee, which will be indicated on your statement. The amount of the fee varies, and it may also be waived as part of a promotion to attract new cardholders. Be aware that cards with an annual fee typically offer you benefits in return, giving you more for your money. 

What is a rewards or cashback program? 

Some credit cards offer a rewards program that allows you to earn points every time you use your card to make a purchase. You can then redeem these points for rewards such as products, services, travel or even cash.  

The number of points awarded with each purchase and their redemption value varies from one rewards program to the next. For example, a purchase at the grocery store may earn you three points for every dollar spent while a purchase at a clothing store will only earn you one point. 

Other cards may offer cashback. Instead of earning points, users receive a cash amount, which is usually a percentage of purchases made with the card. This cashback can be credited directly to the credit card balance or deposited into a bank account or other account for reimbursements. 

Be sure to read the rewards program’s terms and conditions carefully before enrolling so that you understand how it works. That way you’ll be able to take full advantage of it. 

To learn how to get the most out of your rewards program, read our article “How to maximize credit card rewards”.  

How do the different types of credit card insurance work? 

Some credit cards also offer other benefits such as insurance for purchases you make using your card.  

Here are a few examples: 

  • Purchase insurance: Protects you against theft and certain damages. Many cards also extend manufacturers’ warranties. 
  • Mobile device insurance: Protects your mobile device in case of accidental breakage, loss or theft. 
  • Trip cancellation insurance: Reimburses certain travel expenses paid with your card (airfare, hotel reservations or car rentals) in the event of cancellation. 
  • Delay, theft or loss of baggage insurance: Provides compensation if your luggage is delayed, lost or stolen. 
  • Travel medical insurance: Provides you with medical coverage abroad for a certain period of time. 
  • Vehicle rental insurance: When you rent a vehicle with your card, it will be covered by your card’s auto insurance. 

How do you choose a credit card that’s right for you? 

Insert video: What credit card is best suited for you?  

Take into account your needs and lifestyle when choosing a credit card.  

Here are a few additional factors to consider: 

  1. Eligibility requirements (such as minimum income) 
  2. Annual fee 
  3. Insurance, warranties and other benefits offered (such as VIP lounges at the airport) 
  4. Rewards and cashback programs 
  5. Options for using your reward points 
  6. Interest rates 

Remember that a credit card should not be a source of debt, but rather a convenient payment tool, especially for online purchases. It also comes in very handy for making hotel reservations or renting a vehicle, for example. If you have financing needs, there are other options such as a personal line of credit, which typically has a lower interest rate than a credit card. 

Would you like to discuss this with us? Contact your National Bank advisor or your wealth advisor at National Bank Financial. Don't have an advisor?   

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Photo of four National Bank Mastercard credit cards

Travel, rewards points, no annual fees, cashback, you name it, we’ve got it!

Discover more