Over 90 million credit cards are circulating in Canada, and a lot of those are carrying a balance. In fact, the average credit card balance for Canadians is currently over $4,200. With an average interest rate of 20% on credit cards in Canada, that adds up to a lot of profit for card providers, and a lot of debt for consumers.
If you have a credit card, it’s important to understand not only what interest rate you’re paying, but how such rates are calculated. Here’s a look at how credit card interest rates work so you can ensure you can make informed decisions about your card usage. Further, we’ll provide strategies to help you tackle mounting credit card debt.
Key Points
- Credit card interest rates tend to be quite high compared to rates on other credit and loan products.
- Credit card interest is only charged on the balance you carry forward, and not the full credit limit.
- Credit card debt can accumulate quickly if you continue to carry a balance every month.
- To reduce credit card debt, make more than the minimum payment every month, adopt a debt repayment strategy, and consider transferring your debt to a balance transfer card.
What Is Credit Card Interest?
Credit card interest is the cost of borrowing from a credit card issuer. In other words, it’s the additional amount you pay when you don’t pay off your credit card bill in full by the due date.
Credit card interest is sometimes referred to as APR, which stands for the annual percentage rate. This yearly interest rate is charged on the outstanding balance of your credit card, and while it’s called “annual”, interest is calculated daily (more on that below).
Essentially, interest is the cost of borrowing money from your credit card provider. And because interest doesn’t stop until you’ve paid off your debt in full, your debt keeps growing.
Borrowing more than you can pay off each month can be a recipe for financial disaster. If you only make minimum payments each month, your debt could balloon out of control and do major damage to your credit score.
How To Calculate Credit Card Interest?
In Canada, when you charge something to your credit card, most providers give you a grace-free period of at least 21 days in which you aren’t charged interest and you don’t have to make a payment. At the end of the grace-free period, you’ll receive a statement that tells you how much you owe.
You’ll be charged interest if you don’t pay off the balance by the set due date. Even if you make the minimum payment, you’ll be charged interest on the amount remaining. So, for example, if you owe $200 but make a minimum payment of $50, interest charges will start to accumulate on the remaining $150.
While interest rates are often referred to as annual percentage rates, the interest owing is calculated daily. This is important to understand because it means you’re not just charged interest annually or even once a month when your bill comes due. Rather, every day you don’t pay off a balance in full, you’re being charged interest on the remaining debt.
To calculate your credit card interest, follow these steps:
Step 1: Find Your APR
This rate is usually detailed on your credit card statement.
Step 2: Convert The APR To The Daily Rate
Divide your APR by 365 (the number of days in one year). For instance, if your APR is 20%, the daily rate would be 20% ÷ 365 = 0.05479% (let’s round that up to 0.055% to keep things simple).
Step 3: Calculate Daily Interest
Multiply your average daily balance by the daily interest rate. For example, if you carry a balance of $4,000, your average daily interest charges are $2.20 per day ($4,000 x 0.055%).
| Average daily interest charges = Credit card balance × daily rate = $4,000 × 0.055% = $2.20 |
Keep in mind that this is assuming that your balance will remain the same each day during the billing cycle. If you spend more throughout the cycle, or make partial payments during the cycle, the daily balance may change.
For the sake of simplicity, we’ll assume the daily average balance remains the same. In this case, on the first day of interest being charged, you would owe $4,002.20:
| Day 1: Average daily interest charges = Credit card balance × daily rate = $4,000 × 0.055% = $2.20 |
Step 4: Repeat The Process
It’s vital to understand that to figure out the overall interest owing, you don’t just keep adding $2.20 each day to your balance.
Interest on credit cards is compounded daily, meaning that each day the interest is calculated based on the previous day’s balance, which includes the interest charged on that day. So, you end up paying interest on interest, which can very quickly add up.
Here’s what that looks like, expanding on the example above:
| Day 2: Average daily interest charges = $4,002.20 × 0.055% = $2.20 New balance at the end of Day 2 = $4,002.20 + $2.20 = $4,004.40 |
| Day 3: Average daily interest charges = $4,004.40 × 0.055% = $2.20 New balance at the end of Day 3 = $4,004.40 + $2.20 = $4,006.60 |
This process is repeated every day.
As you can see, each day the interest is calculated based on the previous day’s balance, which includes the interest charged on that day. This is known as compound interest. Continuing this pattern for the entire 30-day billing cycle, you’ll have a total owing of approximately $4,066.27 by Day 30.
So, after one month, you’ve gone from a balance of $4,000 to owing $4,066.27, which is a significant amount. This is especially true if you continue to carry a balance month after month.
Credit Card Interest Calculators
You don’t have to do these kinds of calculations on your own. Many credit card interest calculators will do the math for you, including one on the government’s website.
To use this calculator, simply enter your credit card balance, interest rate, and desired payment amount or timeline.
What Determines A Credit Card Rate?
Credit card companies in Canada offer a standard rate of between 19.99% and 25.99%. Premium cards with more perks generally have higher rates. If you tend to struggle to pay off your monthly payments and always carry a balance, it may be worth looking into applying for one of Canada’s low-interest credit cards. Some have rates as low as 8.99%, though they may come with an annual fee and not offer a lot of benefits.
It’s also a good idea to look for cards with promotional balance transfer offers, though to reap the benefit of no or low-interest payments, you’ll need to pay off your debt before the offer expires.
Types Of Credit Card Interest Rates
Credit card interest rates in Canada can vary greatly depending on the type of transaction and the card issuer. Understanding the different interest rates associated with credit card use is crucial to managing debt and keeping personal finances healthy.
Purchase Interest Rate
The purchase interest rate is what you’re charged when you make a new purchase to the card. This rate kicks in once the grace period is over and you’ve not paid off the full amount owing. As long as you pay the card balance off in full before the due date, no interest is charged on the purchase.
Cash Advance Rate
Cash advances are when you use your credit card to withdraw cash from an ATM. These types of transactions usually have higher interest rates compared to purchase rates. To make matters worse, interest charges start immediately — there is no grace-free period.
For these reasons, you should only consider a cash advance if you’re sure that you’ll have the money to pay back what you withdraw as soon as possible to stop interest from accumulating. Note that cash advances also often come with an additional fee of anywhere from $2.50 to $5.00 on top of what you’ll be charged in interest.
Learn More: What Is A Cash Advance?
Balance Transfer Rate
When you transfer the balance from one of your credit cards to a different card, the interest rate applied to the transferred amount is known as the balance transfer rate. Sometimes, banks will offer a special low or 0% interest rate if you transfer a balance over to their credit card. These offers are made to entice new clients to sign up.
Balance transfer promotions are good for a limited period, such as six months. Once the promotional period is over, your remaining balance will be charged at the card’s regular APR.
Check out our list of the best balance transfer credit cards.
How To Limit Your Credit Card Interest Charges
If you have very high credit card debt, it can be very stressful and difficult to manage. That said, there are effective strategies you can use to help reduce and manage your debt:
Pay Your Bills In Full By The Due Date
The most obvious and effective way to limit your credit card interest charges is by simply paying off your bill in full by the due date. This will eliminate any interest from being charged. If you can’t make the payment in full, try to make partial payments or at the very least the minimum payment:
- Partial Payments – If you can’t make a full payment, you can help reduce your interest by making partial payments. When you do this, you lower your average daily balance, which will reduce the amount of interest charged.
- Minimum Payment – If you can’t make partial payments, at least pay the minimum amount to help you avoid a late payment penalty.
Set Automatic Payments
If you have a habit of forgetting about credit card payment due dates, consider setting up automatic payments. This will ensure that your payments are made every month so you won’t miss a deadline.
Use A Lower Interest Rate Credit Card Or A Balance Transfer Credit Card
If you’re someone who often carries a credit card balance from month to month, consider a low-interest credit card. You can also apply for a balance transfer credit card to capitalize on low or 0% interest rates for a set period. You can transfer your high-interest credit card balance to one of these cards, and during the promotional period, you can work towards paying down all your debt without paying interest. Just be mindful of balance transfer fees and the expiry of the introductory period when the regular interest rate will apply.
Consolidate Your Debt
If you have a lot of credit card debt, a debt consolidation loan can help you save money on interest. If your income and credit score are still in good shape, you can apply for a debt consolidation loan that has a low interest rate. You can use the funds from the loan to pay off all your existing credit card debt. This can simplify your finances by leaving you with just one loan payment to manage, rather than several. Plus, with a lower rate, you can save money in interest charges.
Learn more: How To Consolidate Credit Card Debt In Canada: A Complete Guide
Final Thoughts
Calculating your credit card interest is a bit involved, but you can find out how much you’re paying much faster and more easily with one of the many online credit card calculators available. Understanding what you’re paying in credit card interest is important as part of your overall budgeting strategy, as is working towards paying down your credit card debt to help you better manage your finances.
