Over 90 million credit cards are circulating in Canada and a lot of those are carrying a balance. In fact, according to credit bureau TransUnion, in the third quarter of 2023, the average credit card balance for Canadians was $4,265. With an average interest rate of 20% on credit cards in Canada, that adds up to a lot of profit for card providers.
If you have a credit card, interest rates and their implications are something you should understand if you want to safeguard the health of your finances. Here’s a look at how interest rates work so you can ensure you can make informed decisions about your card usage.
What Is Credit Card Interest?
Credit card interest is the additional amount you pay when you don’t pay off your credit card bill in full by the due date. It’s 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 (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 fallout. If you only make minimum payments each month, your debt could balloon out of control and do major damage to your credit score.
Basics Of 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. If you don’t pay off the balance by the set due date, you’ll be charged interest. 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 (APR), 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. So if your card has an APR of 20%, to figure out interest, you would divide what you owe by 365 (as that’s how many days there are in a year) and then multiply it by your average daily balance.
Example On How To Calculate Credit Card Interest
Let’s say your credit card has an annual interest rate of 20%. To figure out your daily rate you would calculate 20 ÷ 365, giving you a daily interest rate of .05479% (let’s round that up to .055% to keep things simple). That means that if you carry a balance of $4,000, your average daily interest charges are $2.20 per day (4,000 x .055).
To sum up: Average daily interest charges = Credit card balance × daily rate
= $4,000 × 0.055%
= $2.20
So on the first day of interest being charged, you would owe $4002.20. But 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. Sadly, that’s not how interest works with credit cards.
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 and so on
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, by day 30 you’ve got a total owing of approximately $4,066.28
So after one month, you’ve gone from a balance of $4,000 to owing $4,066.28, which is a significant amount especially if you continue not to pay off the full amount and interest keeps accruing every single day for months, or, worse yet, years.
Make Partial Payments
The best way to avoid interest payments and snowballing debt is to pay your balance in full monthly. If you can’t make a full payment, you can help reduce your interest by making partial payments throughout the month (rather than waiting to make one big payment at the end of the month). When you do this, you lower your average daily balance and will thus pay lower interest overall.
For example:
Let’s say you have a balance of $3,000 and you make a single payment of $1,500 on the 25th day of the billing cycle. Your average daily balance would be:
($3,000 × 25 days + $1,500 × 5 days = 82,500 ) ÷ 30 days = $2,750.
Scenario 2: You make three payments of $500 each on the 10th, 20th, and 30th day of the billing cycle.
Your average daily balance would be:
($3,000 × 10 days + $2,500 × 10 days + $2,000 × 10 days = 75,000 ) ÷ 30 days = $2,500
In the second example, by splitting your $1,500 payment into three smaller payments spread throughout the month (rather than just one big payment made once) you reduce your average daily balance from $2,750 to $2,500. This means you’ll be charged interest on a lower balance, resulting in lower interest charges overall.
Credit Card Interest Calculators
Don’t like math? Don’t worry, 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. By entering your credit card balance, interest rate and desired payment amount or timeline, these calculators can provide a clear picture of your interest charges and help you create a plan to pay off your debt. However, it’s important to remember that these calculators provide estimates only.
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 Advances
Cash advances are when you use your credit card (rather than a debit card) to withdraw cash from an ATM. These types of transactions usually have higher interest rates (ranging on average from 21.99% to 23.99%) than when you charge a new purchase. To make matters worse, interest charges start immediately — there is no grace-free period. For these reasons, cash advances should be avoided at all costs, and if you do have to use a cash advance just be sure to pay it off 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.
Balance Transfer Rate/Promo rate
When you transfer the balance from one of your credit cards to a different card (usually with a lower interest rate), the interest rate applied to the transferred amount is known as the balance transfer rate. Sometimes banks will offer a special low or no interest rate if you transfer a balance over to their credit card. These offers are made to entice new clients to sign up. These balance transfer promotions are good for a set period, such as six months and once the promo period is over, your remaining balance will be charged at the card’s regular APR.
