What is a credit card?
Credit cards are issued by banks, stores and financial services companies. They allow you to buy goods and services by borrowing funds from the credit card issuer.
Credit cards can be used instead of cash when you make a purchase. It’s a good idea to re-pay the money you owe on your credit card by the billing date. If you do not pay off your credit card bill within the interest-free grace period, you will have to pay interest on what you owe.
A credit card is different from your debit card which is connected to your bank’s chequing account. When you use a debit card, money is taken out of your own bank account. When you use a credit card, you are borrowing money that you re-pay later. Some people prefer to use their credit card instead of the bank card because most credit cards offer protection for purchases and against fraud.
As you use a credit card, you build your credit score. This is reflected in your credit report. Your credit score is based on how much money you borrow, how much you are able to borrow, and how reliable you are at paying it back. Having a good credit score can help you get approved if you are applying for a loan.
Learn more about your credit report and score.
What transactions can you make with a credit card?
There are different types of transactions and various fees that come with using a credit card:
- Credit card purchases – You can use your card to buy goods and services. Some stores may add a fee called a merchant surcharge if you use a credit card to pay. You should be informed of this before your payment.
- Cash advances – You can use your credit card to receive a cash advance through an ATM or a financial institution. There is no interest-free grace period. This means interest is paid from the time you receive the cash advance until you pay it fully. There may also be fees each time you get a cash advance.
- Cash-like transactions – You can use your credit card for things like wire transfers between financial institutions, money orders, cheques etc. These are treated like cash advances with no interest-free grace period.
It’s important to keep your credit card safe — check out these tips.
What are the main types of credit cards?
There are many types of credit cards to choose from. They have various features to compare such as fees, interest and rewards. Before you start shopping for a card, it’s important to understand the differentoptions.
| Type of credit card | Key features |
| No-fee card | Often issued by banks No annual fee May offer lower interest rates than store cards |
| Preferred-rate card | Often issued by banks May have an annual fee Often offers lower interest rates than no-fee cards |
| Reward card | Carries the logo of the rewards organization as well as the lender’s logo Offers a special bonus, such as travel miles, cash back or points towards merchandise May have an annual fee Interest rates may be higher May require a minimum number of transactions Learn more about rewards credit cards |
| Store card | Can only be used in one chain of stores or with one company Available from most major department stores, gas companies and phone companies Interest rates may be higher than other credit cards |
How do prepaid and secured credit cards work?
There are two types of cards which work a little differently than typical credit cards:
- Prepaid credit cards
- Secured credit cards
Prepaid credit cards
With prepaid credit cards, you put your cash into the card — this is called loading it. You can then use it like any other credit card. You don’t have to pay back what you spend, because you’re paying for your purchases with your own money. Be sure to read the rules and fees associated with a prepaid card before purchasing it. This includes understanding any fees for activation, usage, maintenance and reloading.
With pre-paid cards:
- You can pay bills, shop at stores or shop online. When the card runs out of money, you can no longer use it.
- You can usually reload the card by going back to the financial institution you got it from. Or you may be able to go online or on the phone and transfer more funds to the card.
Keep in mind, prepaid cards don’t offer the same protection as other credit cards if it’s used without your knowledge. If your prepaid card is lost or stolen, report it.
Secured credit cards
When you use a secured credit card, you deposit funds with a lender to back up — or “secure” — the card. Depending on the lender, you may not be able to deposit more than $5,000. Like pre-paid cards, you aren’t borrowing the money for purchases. You’re spending cash you already have. With secured credit cards:
- You may pay higher fees and interest rates than standard credit cards. And you can only spend the amount of money you have deposited.
- Unlike a prepaid card, you must pay back what you spend. You can get your original deposit back when you close your card, provided you have paid off the balance in full and on time.
A secured credit card may be useful for someone who wishes to build or rebuild their credit history. That’s because the lender may report your payment history each month to the credit bureaus. If you make regular payments, your credit history can improve.
What should you consider when selecting a card?
It’s important to understand credit card fees, your borrowing limit, and how statements work. This will help you keep track of how much you owe, including any interest. Here are eight things to keep in mind about many credit cards:
- You may be charged an annual fee –If your credit card charges an annual fee, ask the lender if they’ll waive it. They may be willing to do this to keep or gain your business.
- Your statement tells you what you owe and when it’s due –The amount due can include any unpaid balance you owe from a previous bill, as well as any new charges, interest, late fees or annual fees.
- Your minimum monthly payment –Most cards ask only for aminimum paymenteach month. This is often 5% of the current balance or $10, whichever is more. Your monthly statement will tell you how long it will take to fully repay what you owe if you only make the minimum payment each month.
- You have a credit limit –This is the amount you can borrow using your card. The lender can’t change this limit without letting you know.
- You may get finance charges –If you don’t pay your bill on time, you may get charged late fees plus interest. You’ll likely pay a higher rate of interest on any cash you borrow using your card and a lower rate on money you borrow for purchases. Your credit card company treats these astwo different kinds of balances.
- You have a grace period –This is the time you have to pay off the balance you owe each month before you have to pay interest. In most cases, the grace period starts on the billing date and ends a certain number of days after. Under Canadian rules, if you pay off your balance in full each month, yourlendermust give you a grace period of at least 21 days on all new purchases. If you don’t, you’ll pay interest on the full amount you owe.
- The annual percentage rate (APR)–This includes allloanservice costs and interest. It may be higher than theinterest rateyou see in the loancontract.
- The introductory rate –This is a special offer that gives you a temporary, lower APR. In most cases, the offer lasts about six months. Then it goes up to the normal rate for your type of card. Your lender must tell you in advance when interest rates are going to increase.
It can take several years to pay off your credit card if you only make the minimum monthly payment. For example, say you owe $4,000 on your credit card. The interest rate is 18%. If your minimum monthly payment is $200 – or 5% – it will take you about two years to get out ofdebt. And you’ll end up spending $800 in interest. Use thiscalculatorto find out how long it will take you to pay off your debt.
How does credit card interest work?
When you receive a credit card, you should know the annual percentage rate (APR). For example, some credit cards will charge interest rates of 19.99% or higher. It is expressed as a yearly percentage, but it’s calculated daily. You can find your daily periodic rate by dividing the APR by 365.
The annual percentage rate (APR)
The APR includes allloanservice costs and interest. It may be higher than theinterest rateyou see in the loancontract. Alendermust tell you the APR before you sign a loan agreement.
To understand the APR on a loan, ask:
- How much interest will there be in total?
- Are there are any fees or extra charges?
- Are there are any other costs, such asloan insurance?
How the lender calculates the interest
The way interest is calculated will affect the cost of your loan. For example, interest on amortgageis calculated in a different way than interest on a credit card. Most mortgages use the remaining balance method. The lender multiplies the interest rate by theprincipalbalance at the start of eachterm. You don’t pay interest on any principal you’ve repaid.
Credit card interest works differently from mortgages. Withcredit cards, you have to pay off all of your charges each month. If you don’t, you’ll pay interest on the full amount you owe. With some cards, you pay interest on your daily balance, or your average daily balance. With others, you pay interest on your highest monthly balance.
The sooner you can pay off your debts, the sooner you can put your money into savings or aninvestmentthat will earn you interest. Learn about strategies to pay down debt.
