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How Do Credit Cards Work?

Updated: Apr 23

They do, of course they do! BUT! if you don't want to get hit with horrible fees read the article below! It's a little long but what is 11 minutes if we save you hundreds of dollars a year just for being in the know about Credit Cards? Exactly.

Credit cards, when used properly, are very useful financial tools and you can use your credit card in different ways to make a variety of transactions. Remember, though, that credit cards work differently for each type of transaction. Let’s look at these different ways of payment and using them.


Credit Card Purchases

Credit cards are useful for a lot of things and you can use your credit card to pay for both goods and/or services. This can be done:

  • at any cash register or checkout that accepts your type of card, a.k.a. a ‘point of sale’

  • over the phone

  • online.

Make sure you keep the receipts from all the purchases you make with your credit card as well as regularly checking your receipts to make sure they match your credit card. If you ever find a mistake in your credit card statement, immediately contact your financial institution.


Cash Advances

Cash advances can be a very expensive way to borrow money. Before you decide to take out a cash advance you should try to see if there’s a cheaper way to borrow the money you need, such as taking out a personal loan or another line of credit. Also when using a cash advance, make sure you try to pay off as much of that balance as early as possible.


There are a few ways to use your credit card to get a cash advance:

  • taking out cash at an automatic teller machine (ATM)

  • getting this cash from a financial institution (bank, credit union, etc.)

There are no interest-free grace periods with cash advances. You start collecting interest the day you get your cash advance and keep collecting until you pay it back in full. On top of that, the interest rate that you’re charged for taking out cash advances is generally higher compared to regular purchases. For example, the interest rate you pay for regular purchases might be 19%, but if you get a cash advance it might be 22%. Another thing to bear in mind is cash advance fees, as this means that you might also have to pay an additional fee each time you get/use a cash advance.

A fee for your cash advance might be:

  • a fixed amount you get per cash advance

  • a percentage of the amount used in your cash advance

  • a fixed amount plus a percentage of the amount of your cash advance

Some financial institutions set a minimum and a maximum amount for cash advance fees. If you’re applying for a credit card from a government controlled financial institution like a bank, the credit card application must have an information box in it. The FCAC (Financial Consumer Agency of Canada) states that, “The information box must present key features of the credit card, such as interest rates, fees and other charges, in a clear and easy-to-understand way.”


Cash-Like Transactions

Financial institutions (banks, credit unions, etc.) often treat the listed kinds of transactions like cash advances:

  • wire transfers, between financial institutions electronically

  • money orders, i.e. a type of payment delivered by a financial institution at your request and is seen as more reliable than using personal cheques because the amount is prepaid

  • travellers’ cheques, i.e. prepaid cheques in fixed amounts that are used by the person signing them to pay for goods and services

  • gaming transactions such as placing bets, buying casino gaming chips and buying lottery tickets (FCAC)

Like cash advances, you will pay interest starting from the date you make the initial transaction. The interest you’re charged for any cash-like transaction is also usually higher compared to regular purchases. You may also have to pay a fee each time you make a cash-like transaction. If you aren’t sure if a transaction is going to be treated as a cash-like transaction or a regular purchase, you can check your credit agreement or contact your financial institution.


Credit Card Cheques

Credit card cheques, which are also called ‘convenience cheques’ or ‘promotional cheques,’ can be used to make purchases the same way you’d use personal cheques. You can also use them to pay your bills or any other debts you have (like outstanding balances on other credit cards).


However, you have to pay interest starting on the date you use the cheque and the interest rate that you’re charged when using a credit card cheque is generally higher than if you used them for regular purchases.


Credit card cheques are linked to your credit card account. This means if you use them to pay for any goods or services the amount you paid will be on your credit card statement. Government controlled financial institutions (banks, credit unions, etc.) must have your consent before they send you any credit card cheques. If you decide to get any credit card cheques as part of a special offer, make sure you understand all the terms and conditions before using them. If you don’t want to use the credit card cheques, make sure you cut up them up before throwing them out so you’re protected against fraud. You also might consider getting in touch with the institution that issued your credit card to ask them to stop sending you credit card cheques in the future.


Balance Transfers

Balance transfers are when you pay off your current credit card balance by transferring it to a new credit card which will generally have a lower interest rate. When doing this, you usually have to pay a fee to get the balance of your original card transferred to the balance of the other card. Balance transfer fees are usually a percentage of the amount you’ve transferred.


For example, if you decide to transfer a $1,000 credit card balance to another credit card that has a balance transfer fee of 3% (1000 x .03), you'll be charged $30 for that transfer.


Make sure that you read the terms and conditions of your credit card carefully before you decide to transfer a balance between cards. Usually, the promotion you’ve applied for will only apply for a specific time. If you’re not sure about something or don’t understand any of the terms you’ve read, ask your financial institution about it. As always, if you apply for a credit card from a government controlled financial institution (bank, credit union, etc.), your application must include an information box. The FCAC states that this information box must present key features of the credit card, such as interest rates, fees and other charges, in a clear and easy-to-understand way.


How are interest charges applied to my credit card?

According to the FCAC, “Interest is the money you’ll pay if you don’t pay your credit card balance in full by the due date.” This is important because you will have to continue paying that interest rate until you pay back your credit card balance in full. Interest rates can depend on a few things such as your specific financial institution and the type of transaction you’re making.


For example, you might have to pay 19% interest on normal purchases and 22% on any of your cash advances or cash-like transactions. Additionally, any rates you have for specific and/or retail credit cards might even be higher. The good news is that your credit card statement and agreement must clearly show you the interest rates you will be paying.[MW1]


What are interest-free grace periods?

You get an interest-free grace period whenever you make a new purchase with your credit card. This ‘grace period’ starts on the last day of your billing period and you can find out when your billing period is/begins by checking your credit card statement. It’s important to know that your grace period does not apply to cash advances, cash-like transactions and balance transfers. Government controlled financial institutions such as banks must provide a minimum 21-day grace period.


For example, let’s say you buy a smartphone using your credit card on January 15 and on February 1 you get your January credit card statement, which includes the smartphone purchase you made on it. A 21-day, interest-free grace period will apply to purchases on your February 1 bill. That means you have until the end of your grace period on February 21 to completely pay off both the smartphone and any other purchases to avoid getting any interest charges on those purchases. (FCAC)


Fees and penalties

Fees and penalties often depend on the type of credit card transaction you’re using and your financial institution. Make sure you read your credit card agreement carefully to know more about those and ask your financial institution about anything you don’t understand.


What are reprinting fees?

Reprinting fees are what your financial institution might charge you when you ask for copies of specific documents like:

  • reprinted statements

  • receipts from transactions on previous statements

You can find out if you have to pay any reprinting fees by checking your credit card agreement or contacting your financial institution. You may also be able to avoid paying reprinting fees by viewing your credit card statements online. The good news is that financial institutions will generally let you access any of your online statements for the last 12 months. Note that you will need to register for online access on your financial institution’s website to get access to this feature.


What are over-the-limit fees?

A credit limit is the maximum amount you’re allowed to spend on your credit card. Unfortunately, your financial institution won't tell you if you’re about to exceed your credit limit, which means it’s your responsibility to pay attention to your credit balance and stay within your limit. If you go over your credit limit, you might have to pay your institution an over-the-limit fee. Fortunately, government controlled financial institutions can’t charge you any over-the-limit fees if a store/business puts a temporary hold on your credit card and that goes over your credit limit.


For example, let’s say you have $90 left in your account before you reach your credit limit and you decide to buy gas with your credit card. The gas retailer decides to place a $100 temporary hold on your card while waiting for you to finish filling up your car and pay for the gas. The gas ends up only costing you $20, and this means the financial institution can’t charge you an over-the-limit fee.


If you’ve noticed that you’re often close to your credit limit, you can ask your financial institution to increase your credit card limit. Additionally, if you don’t want to increase your credit limit, or don’t qualify for a limit increase to your card, you can ask your financial institution to stop any transactions that will go over your credit card limit. It’s important to note that not every financial institution will offer this service and that some low-cost transactions might still go through. If you want to find out if you’ll be charged over-the-limit fees or if any of your transactions over your credit card limit are allowed to go through, read the terms of your credit card agreement and ask your financial institution about anything you don’t understand.


What are dishonoured payment fees?

When you have an account with a financial institution, your financial institution might charge you a fee to deal with a payment that is dishonoured, or that “bounces back.”

This dishonoured fee happens if you:

  • make a payment using a credit card cheque and the cheque is returned/bounced because of non-sufficient funds (NSF)

  • make a payment by using pre-authorized debit and it’s rejected because of NSF

  • use a credit card cheque for a cash advance, and the cheque is returned because you're over your limit

What are inactive account fees?

Inactive account fees occur at some financial institutions when you don’t/haven’t used your credit card for a long time. In some cases, the financial institution might even close your account if your card has been inactive for a year. So if you don’t need or use your credit card anymore, make sure you contact your financial institution to cancel it. However, it’s important to keep or improve your credit score, so think about keeping one credit account open and having a low credit limit while using it occasionally. Make sure you only keep what you need and can manage that credit responsibly.


What are interest rate increases?

Interest rate increases happen when/if you don’t make your required minimum monthly payments by your card due date. Interest rates will generally go up by 5% but the increase can be even higher than that. Interest rate increases may be different based on the type of credit card you have and the institution that issued your credit card. These increases might be temporary or permanent and you might also lose access to a promotional interest rate/annual fee that you were part of if you don’t make your minimum monthly payments by your card due date, which in turn can greatly increase your card interest rate.


Let’s pretend that you have a promotional interest rate of 4% for the first 6 months you have a credit card then, after these six months, the interest rate on your card will increase to the average rate of 19%. However, because you missed making your minimum monthly payments during those first 6 months in the promotion, your interest rate increases to 24% instead. This would look like getting a 20% increase in interest during your promotional interest rate time.

Make sure you talk to your credit card issuer about how much your interest rate can increase if you miss any of your required monthly minimum payments. It’s usually given/written in your credit agreement or in the information box of your credit card application. Government controlled financial institutions (banks, credit unions, etc.) are required to tell you before any interest rate increases take effect.


What happens when I use my credit card in a foreign country?

Two things happen when using your credit card outside of Canada to pay for any goods or services, the financial institution will use:

  • an exchange rate for your purchase

  • a foreign currency conversion charge

What are foreign currency conversion charges?

A foreign currency conversion charge is applied to your transaction after the you’ve made has been converted into Canadian dollars. There are different ways that financial institutions may calculate foreign currency charges. Some foreign transactions are converted directly into Canadian dollars while others might first be converted into U.S. dollars and then into Canadian dollars.


Let’s say you make a €1,000 purchase with your credit card. The exchange rate at that time is 1.42 CAD to change euros directly into Canadian dollars. Plus, your credit card agreement shows that the bank applies a conversion charge of 2.5% to foreign currency exchanges.


After your financial institution is done converting your €1,000 purchase into Canadian dollars, it will cost you $1,420. Then the bank will apply a 2.5% foreign currency conversion charge to the $1,420 you’ve paid for a conversion fee of $35.50 (1420 x .025). Therefore, the total your purchase will be is $1,455.50 Canadian dollars. Your credit card agreement will have the terms for total foreign currency conversion charge in it and you can ask your financial institution about anything you don’t understand.


What are foreign cash advance fees?

Any cash advances done outside Canada will generally have fees that are higher than if it’s done in Canada. Plus, a foreign currency conversion charge might also be applied to any foreign cash advances made. Like cash advances in Canada, you’ll have to pay the interest charges associated with that cash advance starting from the day you take out that money until you pay back the full amount.


What about returning items I’ve purchased outside of Canada?

If you need to return items you’ve bought with foreign currency, the refund you get and what shows up on your bank statement might be a different amount than what you paid for your original purchase. This happens because the exchange rate for currencies changes from day to day, which means the exchange rate might be different on the day your refund goes through.

Although using credit cards may seem daunting they are a great financial asset in today’s world. Just make sure you know and follow the rules and fine print and you’ll do great.


Yes this was long, but now we are sure you learned a few things. Keep this article bookmarked or send us a message through our social media Facebook, Twitter or even DM or Instagram about all your financial questions and we will answer them ASAP!

Gemba Finance Inc is a proud member of the Canadian business community. We strive to educate and collaborate with like-minded businesses to make a difference environmentally and socially. People, Planet, and Profits. Let’s collaborate!

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