Did you know the average Canadian has 2 credit cards, yet most do not know how to use them correctly? The average credit card holder in Canada has nearly $4,000 in credit card debt.
These facts make credit cards sound like the worst idea ever. But, there are benefits to having a credit card, such as:
- Establishing a credit history
- Earning rewards or cash back
- Additional insurance on purchases
- A sense of security from having an emergency line of credit at your fingertips
Despite these benefits, credit cards can become dangerous if you are not financially responsible.
The Golden Rule for Credit Cards
Let’s start with the basics. What is a credit card?
Credit Cards 101
A credit card is essentially a line of credit available at all times up to a designated limit. You can swipe your card at any time to make a payment.
When you use your card, your bank makes a small loan to you for your purchase. They are issuing you a short-term interest-free loan. This loan remains interest-free during your grace period (often 20-30 days). Once your grace period is over you will begin to owe interest on your purchases. Credit cards often have high interest rates. Many interest rates are 15-25%.
You are often only required to pay off a very small amount of the balance you are holding on your credit card. Banks allow you to do this because they earn big bucks from charging you interest. Unfortunately, this is often what gets people into financial trouble.
The Debt Trap
When you only make the minimum payment on your card a few things will happen:
- Your debt will continue to grow. When you pay the minimum balance you are spending money you do not have. This means you are simply the debt you have accumulated and postponing payment to another month.
- You will have interest charges. The banks are more than happy to charge you interest on the balance that you do not pay. Interest charges will continue to accumulate until you pay off your purchases. This can create a snowball effect on your debt.