Credit cards are a prevalent part of our daily lives. The idea of a cash transaction now seems foreign – particularly to those born since the turn of the century! Consumers need to educate themselves in sound credit habits and the best credit cards in Canada.
Canadians spent upwards of $6 billion in 2019 alone on credit card purchases. But that card in your wallet is one of the country’s most significant drivers of household debt. Thousands of customers pay millions in late payment fees each year due to the steep rates charged on credit cards.
It is essential to understand the day-to-day use of credit cards and the fine print that guides their use.
How the Best Credit Cards in Canada Work
Before we delve into credit card best practices, a brief overview of their function is helpful.
Credit cards link to a bank or other lender credit (or loan) account. So, when cardholders use their card at a retail or online store, they are not using cash from their bank account. Instead, the bank lends the funds for the purchase to the account holder.
Most credit cards have a preset “credit limit.” This lender-set amount is the maximum amount of credit (loan) a cardholder can access at any given time. The credit limit essentially represents the upper cap on what you can charge to your credit card.
It is a Revolving Credit Line with a Card
It is best to think of a credit card as a revolving credit line, but with a card to access the funds in real-time.
When you reach the cap, you must make partial or full repayment before spending can resume. If the amount spent is paid in full, the account holder can reaccess the entire credit line. However, if only partial repayment is made, you can only access the repaid amount (and any amount still available on the card’s limit).
The credit card balance reduces once the lender receives partial or complete repayment. The cardholder can then use the card again up to the credit limit. If that sounds confusing, an example is: A Canadian consumer has a $5,000 credit limit. The consumer spends on their card and eventually reaches the $5,000 limit. The lender then stops them from spending more on the credit card.
Then, the consumer decides to repay $3,000 to the bank, bringing the balance down to $2,000. The consumer is now free to spend $3,000 more on the card but still owes the lender an additional $2,000 to reach a zero balance.
Here is the catch, though: credit cards are not free money. Most credit cards allow users to pay back the money they borrowed within a month. After that, they charge interest rates that reach 23% APR or more. That means that in the example above, if the consumer did not pay back the $2,000 balance on time and kept that balance for a whole year, they would then have to pay up to $460 more! That is not including any other fees or penalties.
It is in your best interest to use credit cards that you can afford and manage them responsibly. But how do you go about doing so?
Impacts on Credit Score
Several factors determine your credit score. These factors include payment history, the ratio of used credit versus total available credit, and length of credit history. The report also considers how many inquiries are on the credit file. This credit score accounts for all of your outstanding credit from credit cards, mortgages, and student loans. The score also accounts for utility and other day-to-day bills.
Most people over 18 have at least one credit card, so this credit account is often a major driver of the overall credit score. Payment history is the most critical factor as it tracks how well you manage and repay your debts.
Not paying your credit card bill every month (or whenever it is due) can have a significant negative impact on your credit score. Similarly, ensuring a pattern of on-time repayments can boost your credit profile and score and make you a more attractive borrower. This boost can result in better interest rates and other terms on future credit facilities, such as a mortgage.
Credit Impacts that Matter
Utilizing a credit card is not the only way that credit cards can impact your score. Your score is affected even by deciding to open or close a credit card.
For example, the potential card issuer performs a “hard inquiry” on your credit file when you apply for a credit card. This inquiry is a deep-dive search of the applicant’s credit history to determine their level of risk as a borrower. “Soft inquiries” do not impact the credit score, but hard inquiries lower your score by a few points in the short term. While an actual hard inquiry remains on your credit report for two years, a soft credit search performed to verify your eligibility for a credit card only stays on your credit report for a few months.
In addition, a credit card is considered “revolving credit” since it allows the user to draw, repay, and then draw funds again. This credit arrangement is contrary to term credit, such as auto loans. Over time, these loans are paid back in installments, and the repaid amounts are not accessible once paid. If you have instalment credit, such as a student loan, and you apply for a new credit card, the mix of installment and revolving credit can boost your score. This credit diversity shows lenders you can handle varying types of credit.
The Effects of Closing a Credit Card Account
Lastly, the act of closing a credit card reduces the amount of total credit available to you. As a result, this action potentially increases your credit utilization rate and, therefore, decreases your credit score.
For example, a Canadian consumer spends an average of $1,500 on their credit card each month. The cardholder has two credit cards with a credit limit of $5,000 and $1,000. Currently, the utilization rate would be $1,500 / ($5,000 + $ 1,000) = 25%.
If the consumer decides to close the $1,000 credit card, then the utilization rate is $1,500 / $5,000 = 30%. To a credit agency, that represents a poorer credit candidate than when they had utilization of 25%. As such, it may be worthwhile to keep credit accounts open even if you do not use them frequently.
Picking the Best Credit Cards in Canada
The best credit cards in Canada is a highly subjective matter. Different users have distinct preferences, as well as varying constraints. No single credit card is suitable for all users. However, there is such a thing as the right credit card for you. To find this right card, you can follow the below steps:
Step 1: Know your credit score and obtain a copy of your credit report
In Canada, you are entitled to a free copy of your credit report every twelve months. Take advantage of this privilege, and obtain a copy of your credit information. The report can give you an idea of your credit score and allow you to view what’s affecting your score.
In addition, you can also see if there are any errors on your score and file a dispute if necessary to raise your score. The best credit cards in Canada offer benefits such as lower interest rates, dedicated customer service, or a concierge to assist you with dinner reservations or theatre tickets. Therefore, you must always understand your credit score and what credit cards you are eligible for.
Step 2: Determine your current and future spending habits
Go back to your previous credit card statements, and determine how much credit you use each month. Are you a big spender, or are you thrifty? Do you see this changing in the foreseeable future? You will soon find out why this is important in Step 3.
Step 3: Understand your priorities and position
Part I: Students and people with limited to no credit history
Particularly for students who are just starting their financial journey, student credit cards are entry-level with limited “frills” and no annual fees. Similarly, a secured credit card allows a borrower to pay a cash amount upfront as collateral. Once the customer demonstrates strong repayment habits, the lender returns the collateral, and the account becomes unsecured.
A secured card may be an option for someone new to the country. This option is helpful to borrowers with no established credit history. Knowing what you are getting into right off the bat for these cards is essential. Make sure you ask the following questions:
- Are there any annual fees charged on the card?
- Do my repayments on the card get reported to credit agencies? Some secured cards do not get reported, which defeats the purpose of using it to build your credit score.
The best credit cards in Canada also have “kickers.” For example, some student credit cards have increased credit limits once the borrower demonstrates a good repayment record. Some secured cards also put your security deposit into an interest-bearing account, so the collateral you receive back when you upgrade is more than what you put in.
If you choose between student or secured cards, these perks can be the tiebreaker that narrows down your choices.
Part II: People with specific borrowing needs
Borrowers with specific needs can find cards that offer a 0% introductory APR and low-interest rates on an ongoing basis. For example, if you do not have a consistent income stream or occasionally carry a balance on your account, cards that offer low interest could be the best fit. However, when pursuing this option, ensure you ask questions such as:
- What are the fees for late payments on this card? Is there a waiver option? If so, what are the criteria to meet it?
- What is the APR once the introductory or promotional offer expires?
- How long does this promotional offer rate last before the actual rate kicks in?
Part III: Selecting between cash back and travel rewards
Choosing one of the best credit cards in Canada means determining what you’re looking for – cash back, travel rewards, and/or points. When deciding between the two types of cards, the choice ultimately comes down to what you answered in Step 2.
The Best Cashback Credit Cards in Canada
Canada’s best cashback rewards credit cards provide physical dollar returns based on spending. The cardholder can use these funds to lower the balance on their card, redeem them as a gift card, or direct deposit them to a bank account.
The primary advantage of this type of card is how easy it is to receive the rewards it offers. As long as you keep spending, the rewards keep accruing and can be automatically set to redeem when eligible. If you are not a big spender, then a cashback credit card can be optimal for you as few cashback cards charge annual fees, and rewards redemption is flexible and easy.
On the downside, though, they do not come with the same welcome bonuses and other promotions like the travel rewards cards described below.
Travel Credit Cards in Canada
Credit cards that provide travel-related rewards offer the user air miles or points. The cardholder can then redeem them towards benefits such as flight tickets, accommodations, lounge access, or free baggage checks. This type of card is helpful if you are a regular spender and are willing to wait and defer your rewards for a big payout at the end.
However, most travel cards charge an annual fee due to the attractive offers. If you envision spending a lot on the card, this annual fee is more than offset by the rewards you stand to gain. If not, then the travel card can get more expensive than a cashback card that often has no associated annual fees.
Only spend what you can afford on a credit card. The interest rates on most cards are prohibitively expensive and can send you into a debt trap if you are not fiscally responsible. Make sure to pay your full balance each month whenever possible. Any outstanding balances start accruing interest at the high rates previously mentioned.
Review your credit card statements each month for accuracy. This is important as it allows you to pinpoint any clerical errors that may have happened and identify if you have been the victim of credit card fraud. If you spot any charges you do not recognize, get on the phone immediately with your credit card provider to report any discrepancies.