Clear Up Credit Card Confusion By Learning These Terms
Let’s face it, few people enjoy reading their credit card agreement or, for that matter, any document with legal and financial words and fine print.
But, as your credit card agreement includes a lot of important information that can affect your finances now, and in the future, it is very important to understand the agreement to best manage the debt and to avoid making costly mistakes.
A common reason that so many people skip over their agreement is that it is full of very technical and confusing language.
Don’t worry – we’ve defined some of the most commonly misunderstood terms below.
What is a Credit Card Agreement?
When you sign up for a credit card, your agreement acts as a contract between you and the card issuer. In other words, if you use your credit card, you are indicating that you agree to everything stated in the agreement. That includes conditions, penalties, payment amounts, and deadlines. For that reason, it’s important to be aware of what’s actually in the agreement.
Credit Card Terminology Defined
‘Credit limit’ refers to the maximum total amount a cardholder/borrower can charge/borrow on their card. This is commonly confused with ‘available credit’, which refers to how much more can still be charged over and above the current amount owed on the card / the account balance.
If you try to charge more than your credit limit allows, your transaction may be rejected. Your card may have a feature called ‘over-limit protection’ that allows you to go over your credit limit, but it usually comes with consequences. Most notably, your credit score may be negatively affected and a higher interest rate may be charged on the over-limit amount
Your credit limit will be determined by the lender, and it will be based on many factors, including your credit score and employment history.
Annual Interest Rate
‘Interest’ is the word used to describe the cost of borrowing money. It is the amount that must be paid to the card issuer/lender over and above the amounts charged/borrowed on a credit card or loan. It is usually referred to as a percentage called the ‘interest rate.’ The interest rate is the percentage that is calculated when you divide the interest payable to the card issuer by the balance owed to the card issuer.
‘Annual interest rate’ refers to the percentage amount of your current card balance that you will have to pay the card issuer over and above your current card balance, over the course of a year.
If you want to estimate the monthly interest rate you are being charged, divide the annual interest rate stated on the card agreement or monthly statement by 12.
Most credit cards allow you to pay off your most recent month’s charges over a period of a few weeks, to a month, before the card issuer begins to charge interest on those charges. This period of time, when interest is not charged on your most recent month’s charges, is called the ‘grace period.’ If the grace period is passed, and the most recent month’s charges have not been paid, interest will then be payable to the card issuer on these charges, from the day they were charged to the card.
‘Minimum payment’ refers to the lowest amount you must pay on your card balance each month.
If you fail to make the minimum payment, your card issuer might take action – for example, they may charge a late fee, or report your late payment to the credit bureaus, which may, in turn, harm your credit rating and possibly increase the interest rates lenders will charge you.
‘Annual fee’ refers to the amount a credit card issuer charges you per year to remain a cardholder. Not all credit card issuers charge an annual fee. These are often found on credit cards that offer particular rewards or benefits.
‘Cash advance’ is a transaction when the cardholder/borrower obtains a cash loan/advance from the card issuer. As with charges to the card, the amount that can be borrowed/advanced is limited to the credit limit on the card.
Cash advances do not have a grace period and, as a result, the card issuer/lender will begin charging interest from the day the advance is borrowed. The card issuer may also charge a higher interest rate on advances than it charges on routine charges to the card.
You can often take cash advances out of ATMs, leaving many cardholders thinking they are similar to regular cash withdrawals from a bank account. They are not the same, as cash advances come from your available credit card limit, rather than your chequing account.
Late Payment Fee
Failing to make a required credit card payment on time comes with consequences.
‘Late payment fee’ refers to the amount that a credit card issuer will charge the cardholder if a required minimum payment is not made on time. When you are charged a late payment fee, it is added to the account balance and, you guessed it, the card issuer begins charging interest on this amount as well.
‘Balance transfer’ refers to the act of getting a new credit card and then immediately using it to pay off all, or part of, a balance owed on another credit card. A balance transfer is often made to take advantage of lower interest rates and fees on the new card. Of note, the lower interest rates and fees are often introductory, inducement amounts, offered to get your business from your current card issuer. The interest rates and fees charged by the new card issuer/lender will often increase after a few months.
As some balance transfers come with a fee, be sure to verify all of the new lender’s agreement terms before opening a new card account and then using it to pay off an existing card balance.
Other Important Terms Related to Credit
You may not see these terms in your credit card agreement, but knowing their definitions may help you further understand your credit card.
Credit Utilization Ratio
‘Credit utilization ratio’ refers to the ratio that compares the amount of credit you have used / your current account balance, to the maximum amount of credit you can use / your credit card credit limit. In your credit card statements and reports, you may see this ratio represented as a percentage or a ‘rate.’
This ratio can affect your credit score. Specifically, using a smaller amount of your approved and available credit may help to improve your credit score.
This is one of the most frequently used terms in lending and banking – and one of the most frequently misunderstood.
‘Credit rating’ refers to a score that indicates how reliable a borrower is expected to be by lenders. It is represented as a number or letter grade, and it is determined by many factors: payment history, how much is owed in relation to approved credit limits, the age of the account, the types of debt used by the borrower and, public information about the borrower such as lawsuits or a bankruptcy.
‘Credit score’ and ‘credit rating’ are often used interchangeably, and they are measured by the same traits, but they actually have a few key differences.
‘Credit rating’ is used for businesses and institutions, while ‘credit score’ is used for individuals.
‘Credit score’ is also measured differently. It is represented as a number between 300 and 850, with higher scores being better.
‘Credit bureau’ refers to the 2 companies in Canada that maintain credit histories, ratings, and credit scores on Canadians who borrow money. The 2 companies are Equifax and Transunion. They receive and summarize credit information reported to them by lenders. They then perform calculations to prepare and update profiles/summaries of borrowers’ use of credit that are referred to as credit reports and credit scores.
By law, Transunion and Equifax must provide to you, upon request, once a year, a free copy of your personal credit report. The reports can include errors, so it is important that you review the report and address errors with the credit bureaus.
The terms used in credit card documents can certainly be confusing. Baker Tilly’s professionals can help you navigate the world of credit. From helping you understand the important terms in a card issuer’s agreement to walking you through documents, we can help you through every step as you secure a card, use it, begin to manage your payments, and build your credit rating.
Baker Tilly Ottawa Ltd. is a Licensed Insolvency Trustee and Consumer Proposal Administrator. Its professionals have assisted thousands of individuals, couples, and businesses successfully resolve their debt crises and overcome financial turmoil since 2002. Its passion – its mission – is your health and well-being!