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How Credit Card Interest Rates Work in Canada

Maybe you haven’t bothered to read the fine print on your credit card agreement. But it pays to know the ins and outs of how credit card interest rates work. Fortunately, it’s not as tricky as you may expect. Read on for our plain-language guide to some of the most commonly asked questions.

November 26, 2020 in Learn

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Q: First things first: What are credit card interest rates?

A: Anytime you use your credit card, you’re essentially taking an unsecured loan. (An unsecured loan is one you can get without putting down an asset — like your house — as collateral.) Interest is what you pay for borrowing that money and not paying back the whole balance — yes, all of it — within a specific time period.

 

The key number to know is your annual interest rate (AIR). This refers to the annual rate of interest that would be charged over a year, and is sometimes referred to as annual percentage rate (APR). A low-interest credit card may have an interest rate of 12.99% or less, while other credit cards may have a higher one. Take a look at your monthly statement: You should see your AIR clearly indicated for purchases and for cash advances (that is, withdrawing money from your credit card at an ATM or financial institution). We’ll get into the differences between those rates later.

Q: What is the “interest-free grace period” on purchases?

A: With any credit card, there’s a window that starts from the closing date on their statement and ends on the payment due date. The interest free grace period is usually 21 to 25 days — if you pay off your entire statement balance by the payment due date, your billed purchases will be charged zero interest. Note: this is dependent on when the credit card issuer receives payment and only applies to purchases. See below for how some of the other transaction types are treated!

 

But if you’re late on your payment, or you pay just the minimum due (or anything less than the full balance), you’ll be billed interest on those billed purchases on your next statement.

Q: How is credit card interest calculated?

A: If you owe interest on your credit card purchases, you might assume the amount will be calculated starting from the due date shown on your statement. But, in fact, it’s earlier: The clock often starts ticking on each purchase’s original transaction date. However, this is not always the case as the interest start dates depend on the terms set out by the lender. You will continue to be charged interest until your credit card issuer has received your payment in full and has credited your account.

 

Throughout this time, depending on the credit card the average daily balance is multiplied by the daily interest rate (which is the annual interest rate divided by 365 or 366 if it’s a leap year), then multiplied by the number of days in the statement period to determine the interest charged to you. Interest calculation methodology can vary for different lenders.

 

To do the math on your current balance, look for credit card interest calculators online.

 

To discover how interest is calculated on American Express Cards, see the Cardmember Agreement pertaining to your Card.

Q: Are credit card purchases and cash advances treated differently?

A: Yes. It’s typically more costly to use your credit card for cash advances than for shopping. On your monthly statements, you’ll see an AIR clearly indicated for purchases. You’ll then see a separate AIR for cash advances — it’s usually several percentage points higher.

 

Credit card cheques (also known as convenience cheques) are considered a cash-like transaction, so they’re subject to the same interest rate applied to other cash advances. The exception: Sometimes you’ll get a promotional offer on convenience cheques that gives you a lower interest rate for a short period (for example, six months).

 

You never get the benefit of an interest-free grace period for cash advances and cash-like transactions, which means you’ll start getting charged interest from the time you take out the money until the time you’ve paid off your credit card balance in full. Cash advances and cash-like transactions may also be subject to fees.

Q: What happens if I miss the minimum payment on my credit card?

A: If you’re tardy with a payment, or don’t pay at least the minimum amount due by the payment due date, there are a few consequences. First, anytime you don’t clear your balance in full by the due date, you will be charged interest on billed purchases (see above). Second, there’s a chance your interest rate will go up: If you miss your minimum payment or you are repeatedly late — you risk having an increased AIR applied to your account. (How long you must keep paying this penalty interest rate depends on your credit card.) Third, repeated late or missed payments could negatively impact your credit score.

Q: How are my credit card payments applied? Do they go to the items with the lowest interest rate first?

A: If you’re making only the minimum payment, it will usually go toward the portion of your balance with the lowest interest rate. Payments above your minimum due will be allocated proportionately to each balance with a different interest rate. This means you cannot pay off your higher interest rate balance first and leave the low interest rate balances last. The way payments are applied varies by the credit card lender, so call the lender’s customer service line to inquire if you’re not sure what the policy is.

Q: How do interest rates work if I make a balance transfer from one credit card to another?

A: Say you’re not able to pay off the whole bill for one of your credit cards. If you have a second card that charges a lower interest rate, you could do a balance transfer — paying off what you owe on one card by shifting that amount to another.

 

Even though there’s usually a fee involved (such as a percentage of the amount being transferred), this can still be a good strategic move to reduce your total interest charges. Just remember that balance transfers are treated like cash advances, so there’s no grace period; interest is charged begin on the date of the transaction.

 

Also, if you’re taking advantage of a limited-time promotional interest rate offer on balance transfers, make sure you fully understand the details — particularly fees (if applicable), when the promo period will end, and how much your interest rate will go up when it does.

 

To learn about interest charges on American Express Cards specifically, see our Cardmember Agreements.

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