4.3.1 How credit cards work

From: Financial Consumer Agency of Canada

A credit card essentially provides a short-term loan. Here's how it works:

  • You make a purchase and borrow money from the credit card issuer to pay for it. You have to pay back the money you've borrowed.
  • The credit card issuer sends you a bill once a month, listing all your purchases and showing how much you owe.
  • If you pay your balance in full by the due date, you are not charged any interest (unless you have taken cash advances).
  • If you do not pay the balance in full by the due date, you will incur interest charges, which may be high.

Definition

  • Credit card issuer: A financial institution that offers credit cards. The issuer makes the credit limit available to cardholders and sends payments to merchants for purchases made with credit cards from that institution.

Applying for a credit card

You must apply to receive a credit card. When you do, the issuer does a credit check to decide whether you are a good credit risk—that is, whether you can afford the loan and are likely to pay it back. The issuer looks at factors like your income and your history of paying bills on time. If you have a poor credit history, you may be denied the card or you may be charged higher interest on late payments.

Credit limit

Each credit card comes with a credit limit—a maximum amount you can charge on the card at a time. If you have no credit history, or a short credit history, you will usually start with a low credit limit. Then, as you show that you are a good credit risk, the issuer is usually willing to increase your credit limit.

Tip

You do not have to accept a higher credit limit if it is offered by your credit card issuer. Many people find that deliberately keeping a low credit limit on their credit card helps them avoid overspending. Accept a credit limit that you are comfortable with and know you can manage.

Grace period

You can benefit from an interest-free period, also known as the grace period, when you make purchases with your credit card. To do so, you must pay the balance in full by the current month's due date. The grace period on new purchases officially starts on the last date that is included in your monthly billing period.

The grace period on new purchases must be a minimum of 21 days as long as you pay the full balance by the current month's due date. The 21-day grace period on new purchases applies even if an outstanding balance has been carried forward from the previous month.

Definition

  • Grace period: a period of time (usually 21 days) during which, if you pay your full balance by the due date, you are not charged interest on new credit card purchases.

Types of credit cards

There are different types of credit cards, such as bank cards (Visa, MasterCard, American Express, etc.), store cards (The Bay, Canadian Tire, etc.), and travel or entertainment cards (Diner's Club, etc.) They all have different features, repayment rules and interest rates. The terms of the credit card loan are described in a credit card agreement.

Cash advances

A credit card can also be used to withdraw a cash advance. However, the interest rate on advances is much higher than the rate for some other types of loans, and there is no grace period—interest is charged from the time you take out the cash advance until the time you repay the advance in full. That's why it's best to use cash advances for short-term or emergency situations only.

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