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Credit Card Basics

Published by My Rate Compass Team | Updated Jun 30, 2020
Credit Card Basics

What is a Credit Card?

When a business such as a bank lends you money it is called credit. A credit card essentially allows you to spend the bank’s money and pay them back later, all through the use of a small plastic card.

Credit cards are convenient, secure, and help build your credit rating if you use them responsibly. Paying for goods with a credit card also gives you the backing of the credit card company’s fraud handling measures. If your card is used fraudulently without your knowledge, the credit card company will almost certainly pay you back.

However, it’s important to remember that credit cards have annual fees and/or interest to pay. If you don’t pay off the entire balance each month, then you will pay interest on the balance. If you use a credit card at an ATM you will likely be charged a cash advance fee.

Your credit card will also have a credit limit – the maximum amount  you are allowed to borrow on the credit card at one time. Once you’ve paid off some or all of the credit used, you’ve essentially reset it and the amount paid becomes available again minus interest and charges (as opposed to bank loans where the credit is non-revolving.)

How Do Credit Cards Work?

Your bank will typically give you a monthly billing cycle. This doesn’t necessarily run from the first of each month to the last but is based on your account open date.

At the end of each billing cycle, your bank will send you a credit card statement that shows how much you owe them. You can choose to pay the entire amount – this means you won’t have to pay any interest – or you can choose to pay the minimum amount or some amount in the middle. There is an interest-free grace period where you  are not charged interest on your balance.

If you pay less than the full amount,  interest is charged. which is a percentage of the amount you owe them. Credit card interest is usually calculated daily and charged monthly. Typically, a bank will charge 19.99% interest per month.

Credit card providers typically charge other fees including:

  • An annual fee
  • A fee when you make a payment in a foreign country or in a foreign currency
  • A fee for paying your bill late
  • A fee for using your card to advance cash, such as taking money out at an ATM.

A charge card is a special type of credit card that requires you to repay the entire balance in full each month. American Express is well known for its charge cards.

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Issuers vs. Networks

You get a credit card either from a bank or other financial institution – the issuer. They are the ones who physically issue you the card, extend you a credit limit, set the terms and conditions of use, and deal with customer inquiries.

However, each bank doesn’t run their own credit card network – they all use one or more credit card networks. Some of the major credit card networks in use in Canada are MasterCard, Visa, and American Express. These companies handle the immense infrastructure required to support a worldwide credit card system.

Comparing Credit Cards

There are literally hundreds of different credit cards on the market, all with different interest rates, terms, fees, and benefits. There’s no perfect card and choosing the best one for your needs comes down to your financial situation, credit history, needs, and requirements.

Your credit history will be a big factor in the type and number of credit cards banks will offer you. If you have good credit, then you’ll be offered cards with low-interest rates, high credit limits and additional perks such as the ability to collect air miles or discounts on hotels. If you have a poor credit rating, you will be considered more of a risk and, therefore, only  get cards with higher interest rates and a lower credit limit.

Your age can factor into this too – if  you are young, you won’t have built up much credit history. Consider a student credit card or a charge card to build up your credit rating. Only by using credit responsibly will your credit rating improve.

Your income will also play a big part in which credit cards are open to you – banks want to know that you’ll be able to repay the credit they are extending you. With a steady income  flow coming into your bank account they can see that you have the means to repay your debts.

Apart from choosing the credit card with the lowest interest rate and fees for your situation, you might also want to  consider the extra perks that  come with some credit cards. Some  offer cash-back when you spend in certain shops; others offer a points system that you can use to for example pay for travel with your credit card.

How to Apply for a Credit Card

Applying for a credit card is quite easy, whether you do it in person, at a bank, or online. The card issuer will need some documents from you to gauge whether you are a good fit for their credit card offers.

They will typically ask for pay stubs that show your income, bank statements, or an alternative proof of income. They will also ask for documents that prove your identity and residence, such as a government-issued ID and a utility bill in your name.

Every credit card will have different eligibility requirements. Some will require that you have a minimum annual income. Most require that you are 18 years old,  while others 21.

After you have given the credit card issuer these details and documents, they will typically look over your application and approve/decline it. If  approved, your credit card will be sent to your home address in 7 to 10 business days and you  can begin spending once you activate it.

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