How Credit Cards Work
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Credit cards are widely used and accepted as a method of payment for goods and services in Canada. As the name indicates, when you pay for something with a credit card, you are doing so “on credit” with the trusted assumption that you will pay off the balance of your card at a later date – so, it’s more or less a short-term loan.
Here’s a quick look at exactly how credit cards work, including who issues them, who uses them, and how their interest charges and payments are applied.
How credit card companies operate
When you look at any of the credit cards on our website, you’ll notice they all have one of three logos on them, indicating which of the three credit card companies it was authorized by: Visa, MasterCard or American Express. These companies license credit card branded products to lenders, including banks, credit unions and even stores, who then issue them to you – the consumer.
When you submit a credit card application through a lender, store, or third-party source like Ratehub.ca, it goes to the specified credit card company for approval. Each credit card company is responsible for approving applications and extending credit limits, and makes money by charging fees and interest to its consumers, as well as to the merchants who accept their cards as payment.
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How consumers use credit cards
If your credit card application is successful, you’ll receive a new credit card in the mail for which you are the primary cardholder of. Once you activate it, it’s yours to use as a method of payment. Your credit card will come with a credit limit, which is the total amount you can charge to it. Any merchant who accepts your credit card will receive payment from the credit card company on your behalf, while you are responsible for paying off the balance of your card.
Now, not only can you look at credit cards as short-term loans, but they are also a “revolving” debt; this means you can continue to “borrow from” (charge) them, even after you’ve paid off your previous outstanding balance. For example, if you have a $5,000 credit limit and you owe $1,000 on it, you can make a $1,000 payment and then borrow up to the full $5,000 again if you need to. The credit card company approved you for a specific credit limit, and if you’re a responsible borrower, it will always be there for you to access.
It’s important to know that more than one person can have access to the same credit card account. At anytime, you may be able to request extra cards for authorized users of your account, such as a child, partner or spouse. However, the primary cardholder is the only person responsible for paying off any amount owing, and whose credit history would be tarnished for overspending or missing payments. For this reason, it’s extremely important to only let people you trust become authorized users of your account.
Credit card statements and dates
At the end of your billing cycle, your credit card issuer (which is likely a bank or store, not the credit card company itself) will send you a credit card statement that outlines all the transactions (both purchases and payments) you made throughout the month. There are a few things to be aware of, when you read your credit card statement.
First, there are two important dates: the statement date and the payment due date. The statement date is simply the date this statement was printed for delivery to you. The payment due date, however, is the date your minimum payment is due. The number of days between the statement date and the payment date is known as the grace period; it’s generally 21-25 days and is the length of time can pay off your balance in full without incurring credit card interest charges on the balance.
For example, let’s say your credit card statement was printed on June 1st, 2014. If the payment due date was June 22nd, 2014, that would mean your card had a 21-day grace period. So long as you paid off the balance in full (not just the minimum payment) during the grace period, you would not be charged interest on the balance. However, if you cannot pay off the entire balance, you will be charged interest on the entire balance on your statement – and it goes back and starts to accrue from the date you made each transaction.
Minimum payments and other credit card fees
Whether or not can you pay the balance in full, you must make at least the minimum payment each month, in order to avoid interest rate increases or damage to your balance transfer fee or cash advance fee. As well, it’s important to remember that some transactions demand for interest to start accruing immediately; these include balance transfers, cash advances, and cash-like transactions such as the purchase of money orders or casino chips.
How credit card payments are applied
When you make a payment to your credit card, it does not automatically go towards paying down the balance of what you originally spent – first, it goes to pay off a portion of your interest charges as well as any other fees included in your statement. If you carry a balance on your credit card, this is why you don’t see it go down quickly enough – because whatever is leftover from the months before has continued to accrue interest, which accrues more interest the next month and continually results in a larger balance.
How to close a credit card account
Both the primary cardholder and the credit card issuer are able to close a credit card account at anytime. However, if your card has an outstanding balance at the time the account is closed, you are still responsible for paying it off in full.
One last thing to keep in mind is that part of what makes up your credit score is the length of time you have been building your credit history. For that reason, it’s suggested that you never cancel your oldest credit card, because it’s been helping you establish your credit history for the longest period of time.
Credit cards are one of the most convenient ways to pay for goods and services; they are widely accepted by merchants in Canada, as well as in more than 200 countries worldwide, and allow you to borrow money in the short-term and potentially get some great rewards, if used responsibly. To use them to your advantage, always pay off your balance in full during your grace period, and you shouldn’t have to worry about interest charges or the minimum payment credit card debt trap.