Carry the Credit Card, Not the Debt

There’s no stress hurricane quite like debt worry, and there’s no debt that causes worry quite like credit cards. But it doesn’t have to be that way. Credit cards have their upsides. They offer more access, options and flexibility for payments and purchases. Some also offer exclusive benefits and loyalty programs, helping you save money on merchandise or travel. Credit cards are also a key tool in building a good credit score, which you’ll need to buy a home, secure a loan or even get a mobile phone.

There are also wallet-draining downsides. If you’re like most Canadians and consistently carry a balance on your credit cards, it may be costing you more than you realize. Understanding how interest is calculated could help prevent you from getting stuck in an increasingly expensive cycle of debt. Knowledge is power. Having and using it could set you on a path to eliminating debt stress for good.

How interest works

Depending on how you manage your credit cards, the interest you pay could be high, low or nothing. That’s because interest is calculated on a daily basis and is charged only if you carry debt from month to month. Knowing how credit card issuers calculate interest can help you understand the true cost of your credit card debt. But first, read the jargon below.

How interest adds up

To determine what you owe in interest, your credit card issuer converts your APR into your DPR and then calculates your ADB.

It then takes each day’s interest charge and adds it to the next ADB, compounding the interest until the end of the billing cycle. Your new balance is then posted, minus any payments or credits.

Annual Percentage Rate (APR)
This is the interest you pay if you carry a balance on your card for 12 months. There are also sneaky rates within an APR that adjusts the interest you pay for purchases, cash advances and balance transfers.

Average Daily Balance (ADB)
This is the average balance that you carry over the course of a month.

Daily Periodic Rate (DPR)
This is the rate of interest that is charged to your card every day.

Compounding Daily Interest
This is where the interest really racks up, as the previous day’s interest is added to the next day’s balance until the end of that month’s billing cycle. If you don’t pay your balance at the end of your billing cycle, that interest continues to compound every day from there.

RRSP deadline for 2018 contributions is March 1, 2019.

So if you owe $5,000 on a credit card with a 20% APR, the interest rate is broken down and charged on whatever balance you have at the end of your monthly billing cycle. If you pay it in full, you’re charged zero interest. If you don’t, you’re charged a daily interest rate of 0.055% (20% divided by 365 days). That’s about $2.75 per day. On day two, your balance is $5,002.75 and now you’re paying interest on the interest you’re being charged, and that keeps happening. Only making minimum payments? It would take you 109 months to pay it off in full. The total interest paid over that period - a whopping $5,840.11. Thanks to daily compound interest, you’ve now paid more than 100% of your original debt in interest payments.

Late and missed payments

If you pay even one day past your due date, you could be stuck with an additional hefty fee that will be tacked on to your next billing statement. If you do it again, you’ll incur more late fees and your interest rates may rise. Keeping in mind the compound interest explained above, this increases the daily interest as well. If you happen to miss a payment or even pay less than the minimum, you’ll be charged additional interest, resulting in an even higher balance in the following billing cycle. It can also damage your credit rating, which could harm your chances of getting other lending products.

Consider alternatives

Personal loans have a much lower interest rate than credit cards, so this may be an option for big purchases or consolidating your debt. A Home Equity Line of Credit or HELOC is another option that provides revolving credit to homeowners who have equity that they can borrow against.

Get the right people on your side

If you’re carrying balances on your credit card, you’re not alone. Understanding how a credit card works is the first step to freeing yourself from worry. If you need help making sense of the fine print, just ask us. It will pay off for you in the end.  In addition to exploring other options to consolidate credit card debt, you should try to pay your balance off in full before the end of your monthly billing cycle. If you can’t do this, make sure you:

  • make your payment before the due date

  • pay more than the required minimum balance

  • access and review your credit report annually to ensure everything is correct

Like any financial product, credit cards have pros and cons. You should be active in your relationship with credit. Balanced with a healthy dose of consumer knowledge and a little financial diligence, credit cards can play a positive role in your financial toolkit.


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