Key takeaways:
- Credit cards allow you to borrow money to make purchases, reserve services or products, or immediately access cash.
- To avoid paying interest, you need to pay your credit card balance in full before the end of your billing cycle.
- Credit cards can build your credit score if you pay your balance on time – but they can lower it if you don’t.
- Credit cards should be a convenient payment tool, not a source of debt.
- Certain credit cards offer rewards or cashback programs.
What is a credit card?
A credit card has many purposes. Like cash or debit, it’s a payment method used to make purchases or pay bills. Unlike them, it allows you access to funds via a short-term loan – the credit card issuer lends you money that you ideally repay on a monthly basis. A credit card is also more than a payment method: it’s a tool that helps you build a credit history. By showing that you can reliably pay off your credit card balance, you can more easily gain access to essentials such as housing (potential landlords will want to run a credit check), phone plans, car loans, mortgages, and more.
How do credit cards work?
Credit cards can be used to pay for goods and services online, at in-person locations, over the phone, or by mail. Using one involves several steps:
- When you give the merchant your credit card number, they send the details to a payment processor that sends it to a credit card network that locates the institution that issued the card. The issuing company checks the information and approves or declines the transaction. This is all done almost instantaneously.
- Once you’ve made a purchase, the amount of the purchase will be deducted from your total credit card limit, which is set by your credit card company.
- At the end of each month or billing cycle, you’ll receive a credit card statement that includes a list of all your recent transactions, any money owing on your previous billing cycle, the total amount you currently owe, the minimum amount you must pay, and the date by which you must pay your credit card bill.
What credit card fees should you be aware of?
Generally speaking, credit cards come at a cost. While many cards have no set fees, they aren’t free to use if you carry a balance from month to month. It’s important to go over the terms and conditions of your card to ensure you’re aware of any potential extra costs. Here are some of the fees that could apply:
- Many cards come with an annual fee just to use the card. In return, you may get access to travel perks, insurance coverage, cash rewards, and more. The key is to ensure that the value of the bonuses you would actually use exceeds the fee you’re paying plus the rewards you would get with a no-fee credit card.
- If you make a payment after the due date indicated on your monthly credit card statement, you’ll incur a late payment fee.
- When you use your card to access cash, you’ll pay a cash advance fee. And unlike with regular purchases, there’s no grace period – you’ll start owing interest on the loan immediately.
- To reduce interest costs, you may choose to transfer your balance from one credit card to another. In doing so, you’ll be charged a balance transfer fee, which is typically 1% to 5% of the amount transferred.
- If you exceed the credit limit authorized by your credit card issuer, you’ll be charged a penalty – called an overlimit fee – but only if you’ve opted to allow transactions that exceed your set limit.
- When travelling or making online purchases through another country, you may be charged a foreign transaction fee for making a transaction in a foreign currency.
What types of credit cards are there?
There are several types of credit cards available – the key is determining which one best fits your needs at a given point in time. Here are some examples:
- A secured credit card is a great tool for building or rebuilding your credit score. This card requires a security deposit, often equal to the balance limit, to be activated. Using a secured card responsibly can gradually lead to positive credit.
- Unsecured credit cards are the most common type of credit card. The credit limit is based on several factors, including the user’s credit score and history, and their earning capacity.
- A rewards credit card offers users discounts on travel, groceries, entertainment, and more, or cashback based on how much they spend (and where) each month.
- A store credit card is issued by a particular retailer, allowing users to earn rewards when making transactions with that specific retailer.
- A business credit card works like a traditional (or personal) credit card but is more likely to offer business-type advantages (discounts for business travel at certain hotel chains, financial tracking, and more).
- A student credit card typically has lower credit limits and is tailored to young adults who are beginning to build up their credit history.
What are credit card interest rates?
When you use a credit card to make a purchase or take out a cash advance, you may incur interest.
- How is interest calculated on your purchases?
If you pay your balance in full by the due date on your monthly credit card statement, you won’t pay any interest on your purchases. Otherwise, interest will be charged starting from the day you make a transaction and will be added to your next statement balance. The interest rate charged on your purchases is calculated on an annual rate. To find out how much interest you’ll pay each day, divide it by 365 days. For example, if the interest rate is 20.99%, the daily rate is 0.0575%.
It’s important to keep in mind that even if you pay off part of the balance, you’ll still be charged interest on the total amount of your purchases until the outstanding balance is paid in full. The interest is always calculated from each transaction date.
- How is interest calculated on cash advances?
Your credit card also allows you to withdraw money or make certain transactions such as bank transfers or cheque payments. These transactions are called cash advances. In this case, there’s no grace period – interest begins to accrue starting from the transaction date and stops only once the amount is paid in full. It’s important to know that cash advances generally have a higher interest rate. Check your credit card agreement for terms and conditions.
Pro tip
Some credit cards charge
lower rates, so it’s always best to shop around before settling on a company.
How do minimum payments and repayments on your credit card work?
If you’re unable to pay off your credit card balance in full, you’ll nevertheless be required to make a minimum monthly payment. However, a minimum payment isn’t best practice – it simply means that you’re staying afloat, not that you’re moving forward in your good credit journey. Best practice is to pay off your entire balance, not just make the minimum payments, by the due date on your monthly credit card statement. That will also help you avoid paying interest.
- Repayments vary depending on where you live. For Canadian residents outside of Quebec, it varies from bank to bank but is generally around 3% of the total balance (purchases, interest, fees, etc.). In Quebec, the minimum payment is 5% of the total balance or $10, whichever is greater.
How much is too much when it comes to your credit limit?
Technically, your limit is the maximum amount you can use on your credit card. However, it should be viewed as a buffer, not as actual spending power. The limit is set by your financial institution based on your credit history and other factors. You can accept the maximum limit offered to you or choose a lower one (some cards have minimum limits). Here’s what to consider when deciding what the right limit is for you:
- Your credit score: Ideally, you shouldn’t use more than 30% to 35% of your available credit. If your balance climbs too high, it will have a negative impact on your credit rating. Your credit limit should be high enough to allow you to use your card without worries, but you should always try to keep your balance well below that limit.
- Your financial capabilities: Your credit limit should correspond to your monthly budget. If the limit is too large for you to pay off within a month, 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’s high enough, so you don’t get too close to it when you use your card, and one that respects your financial capacity.
-> Here’s how to apply for a credit limit increase. Discover other tips for using your National Bank credit card.
How does a credit card help you build better credit?
Your credit card can have a major 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.
-> Here’s how to build or rebuild your credit score.
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 you can take full advantage of it.
-> Here’s how to maximize credit card rewards.
How does 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 covers you when you use your card to rent a vehicle.
How do you choose a credit card that’s right for you?
When choosing a credit card, it’s important to take into account what you plan to use it for, your current lifestyle, and your ability to repay on time. Here are a few additional considerations:
- Eligibility requirements (such as minimum income)
- Annual fees
- Insurance, warranties, and other benefits offered (such as VIP lounges at the airport)
- Rewards and cashback programs
- Options for using your reward points
- Interest rates
Remember that a credit card shouldn’t be a source of debt, but rather a convenient payment tool, especially for online purchases and reservations, and for building credit. 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.
For further information or to discuss your options, don’t hesitate to reach out.