Do you understand how your credit card works?

06 May 2020 by National Bank
Credit Card 101: How Does It Work?

Do you really know how your credit card works? Interest calculations, minimum monthly payments, cash advances, credit scores, purchase protection policies: our expert answers the most frequently asked questions about how the payment solution that is your credit card works. 

1. How does credit card interest work?

“After your monthly statement has been issued, you have 21 days (the grace period) to pay off your credit card,” explains Pascale Arès, Product Manager, National Bank Credit Cards. “If you pay off your bill in full before the due date indicated on your monthly statement, you won’t have to pay any interest on your purchases. If not, you’ll accrue interest in your account.”

Here’s how interest is calculated and what you have to know:

The card’s rate is annual

Every card has an annual interest rate, which means the interest rate is calculated over a 12-month period. For example, with an annual rate of 20.99%, divided by 365 days, gives us a daily rate of 0.0575%. You can take this daily rate, multiply it by your purchase total, and multiply that by the number of days since the purchase date indicated on your monthly statement.

Let’s say you buy a pair of pants for $100. When you receive your monthly statement, you only pay back the monthly minimum. With an annual rate of 20.99% – meaning a daily rate of 0.0575% – you’ll pay about $0.06 per day in interest on top of your purchase total. Over 30 days, you will have accrued $1.73 in interest.

Interests are calculated on your purchase total

Most people don’t know that if their balance isn’t paid off in full, the interest will be calculated on their entire purchase total, not on the amount left to pay. This calculation is done according to the transaction dates that appear on your statement.

“Let’s say you make a $30 purchase on May 1, and a $70 purchase on May 10. If you only pay back $25 of your $100 total, the interest will be calculated on $100 as of the date on which each purchase was made according to your statement. For an annual rate of 20.99%, that means a daily rate of 0.0575% calculated from May 1 for the $30 sum, and this same rate will be calculated as of May 10 for the $70 sum. Please note that interest only accounts for your purchases. You won’t accrue interest on your interest fees.”

Tip: To find out how much interest you will have to pay on a certain amount depending on your payments, you can use the calculator provided by the Financial Consumer Agency of Canada (FCAC).

Interest is charged on a cash advance as soon as you collect it

Cash advance refers to cash you can withdraw from your credit card account and operations that can be converted to cash directly (e.g. cheques, bank transfers, lottery transactions, etc.). You start to accrue interest as soon as the transaction is completed. Contrary to purchases, there is no grace period to pay it back. Read your cardholder agreement carefully, as the interest rate for cash advances is usually higher than for purchases. National Bank customers can easily find this information on their monthly statement.

Tip: To reduce your interest fees, consider a card with a low interest rate. “To give you an idea, National Bank’s Syncro card offers an annual rate as low as 8.9% for purchases and 12.9% for cash advances. This could be a good option for consumers who don’t pay off their balance in full every month.”

2. How are minimum monthly payments calculated?

It’s possible that you may not be able to pay off the balance on your credit card in full every month. That’s why financial institutions, as per the regulations stipulated by the Consumer Protection Act, always require a minimum payment.

According to the Consumer Protection Act in Quebec, for any consumer who’s signed up for a new credit card after August 1, 2019, this payment must amount to 5% of their balance total (purchases, interest, fees, etc.) or $10, depending on which sum is higher. For customers who signed up for their card before this date, the increase in the minimum payment will occur gradually, according to the terms of the credit card issuer. For residents of Canada, excluding the province of Quebec, the minimum payment varies from one financial institution to another, but it’s generally around 3%. This information is available in the cardholder agreement; for National Bank customers, it also appears on their monthly statement.

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3. Are credit cards necessary for building a credit score?

No, a credit card isn’t absolutely necessary, but it’s certainly a good starting point for building a credit report and a good credit score. A credit score is a rating based on the information contained in your credit report, which delineates your entire credit history.

A credit card allows you to start off with a modest limit, like $500. It’s a good way to test your repayment habits, like paying on time and taking care of your balance in full.

4. How does the purchase protection on a credit card work?

One of the benefits of paying with a credit card is purchase protection, which is offered with all Mastercard and National Bank credit cards. This protects your purchases from loss, theft or damage. In some cases, it also allows you to extend the manufacturer’s warranty twofold or threefold. Obviously, this applies as long as you made the relevant purchases using your credit card.

“Each card is unique, so you have to read its purchase protection policy.” For National Bank customers, this information is available on your credit card’s information page online.

5. How do you choose a credit card?

The simplest answer is to choose one that meets your needs. There are all kinds of rewards programs that offer travel discounts, cashback, gift cards to various stores, etc. Also, pay attention to the interest rate, to the insurance coverage provided, and to other fees tied to the card, like annual fees and incidental charges.

You can make a shortlist based on your needs and lifestyle. Then, take a look at the annual fees and interest rates related to the offers you’re interested in. The number of transactions you make per year could also help determine the best option for you.

A credit card is a handy payment tool as long as you use it properly and make use of its benefits:

  • It’s an effective tool for managing your financial resources, bills and day-to-day transactions.
  • It allows you to make contactless payments using features like digital wallets.
  • It allows you to safely conduct online transactions.
  • It helps you build your credit report.
  • It offers some warranty and consumer protection, like travel insurance and an extension on the warranties provided by manufacturers.
  • Finally, it’s handy for travellers because it’s a payment method that’s accepted almost everywhere in the world.

“It’s a safe payment solution. And I emphasize ‘payment solution’; your credit card shouldn’t be considered as a source of financing,” Pascale Arès concludes.

Take a look at our credit card offers to find the one that best meets your needs.

To increase your credit card limit, see the steps to follow.

For your financing needs, there are many options depending on your personal situation and your goals.

For more tips on personal finance, sign up for the National Bank newsletter.

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