How Credit Cards Work

You may enjoy the convenience of being able to buy on credit, but do you know how credit cards work?
“Understanding how credit cards work can save you a great deal of money in interest and charges. Tackling this important financial literacy task can also help you to pick the card that is right for you to achieve your financial goals and to stay out of debt trouble,” says Jeff Schwartz, Executive Director, Consolidated Credit Counseling Services of Canada.

Has your credit card use left you with an unmanageable debt load? Seeking debt relief will not only help you pay your debt down today, you’ll gain necessary financial literacy tools to stay debt free going forward.

How Credit Cards Work

Call one of our trained credit counsellors at 1-844-329-7254 or check out our free online debt analysis.

Revolving credit

Credit cards are considered revolving credit. This means that you are assigned a credit limit and you are able to reuse them over and over again as you pay the balance down.

Minimum payment

You are required to make a minimum payment each month, based on a percentage of your balance. This payment is made up of both interest and principal, but truthfully most of it goes towards interest. That’s why if you are only making your minimum payment every month, it is extremely hard to pay the debt down.

Your payment is usually calculated using the balance outstanding and the interest rate on your card, along with your credit history and credit score.

Purchases vs. cash advances

Not all activity that you use your credit card for is treated the same, so it is important that you know the difference in how you are charged. When you make a purchase with your card (i.e. through a retailer or service provider), you have 21-30 days to repay the purchase amount before you are charged interest.

This is called the “grace period”. Cash advances, however, start accumulating interest as soon as you take them out.

“Taking out cash advances can be a very costly way to borrow money. Firstly, you start incurring interest charges immediately. Secondly, many credit cards charge a higher interest rate with a cash advance than they do with regular purchases. You may also incur an additional fee for a cash advance. All in all, you are paying a premium to take out a cash advance on a credit card. Try to avoid this habit, “ says Schwartz.

Balance transfers

Using a credit card balance transfer can be an effective way to consolidate your debts, which can help you pay your debt down more quickly. When you do a balance transfer, you may be charged a fee from your financial institution, which is typically a percentage of your balance.

In most cases a balance transfer is done to a card that has a lower interest rate as part of a debt consolidation plan, make sure that you read all the fine print around charges for balance transfer activity, because you don’t want to end up paying more than you were expecting. Also be on the lookout for any promotional periods with balance transfer interest rates. Commonly, credit card companies will promote a specific card with a very low interest rate as a good balance transfer tool, to get you to transfer your debt to them. On the surface, it is very appealing and can be a money-saving move, but these low interest rates are often for a limited time, which means that if you haven’t paid the debt off during the introductory time period, you’ll be on the hook for paying high interest on your balance.

How to read your credit card statement

It may not make for the most interesting reading, but it is essential that you read your credit card statement in detail. You can first of all check for errors or fraudulent activity. But knowing how much you owe, when it is due and how your interest is being calculated can help you budget, be timely with your payments and help to keep your credit in good standing. It’s a good idea to keep all the receipts for your purchases and then reconcile them against the activity that you see on your credit card statement. If something doesn’t add up, or if there is an activity that you can’t account for, notify your creditor immediately. This way, they can act quickly to assist you.

Credit card statements can be pretty confusing, but they generally contain a lot of the same information in a similar format. In fact, credit card companies are required by law to display certain information every month to a card user.

Here are some of the things that you should watch for on your statement.

Your balance: This is the amount that is on your card on the final day of your reporting period. This will include all of your purchases, cash advances, interest charges and other fees.

Minimum payment and due date: This line shows what your minimum payment amount is for the month and when it must be paid.

Account summary: This lists all of your activity on your credit card over the last month. Generally, this will occupy the bulk of the space on your credit card statement. You’ll also see here what your credit limit is and how much room you still have left on your card.

Reward information: If your credit card is part of a reward program, your reward points etc. will be listed in this section.

Annual Percentage Rate (APR): the APR is the percentage that you’ll pay over the course of a year to borrow money through your credit card. It is important to know this number and to understand how it is calculated because it can help you accurately compare credit cards to each other and to determine how expensive your credit use ultimately is.

Your credit card statement will outline the consequences and costs of late payments on your card. It will also will provide information on how long it would take you to pay your credit card off making only the minimum payment. This information can be very helpful in motivating you to pay your debt down more quickly by encouraging you to make more than the minimum payment after realizing how long it will take using a minimum payment method.

Want to learn more about how you can reduce your credit card debt? Call us at 1-844-329-7254 or check out our free online debt analysis.