So you say you want a credit card?
Does it seem like all of your friends are living large and spending more? It’s common for people to feel the Fear of Missing Out (FOMO) -- when they think others may be experiencing better things or having more fun. Buying based on FOMO has increased with the rise of social media. In fact, 50 per cent of adults aged 18 to 38 say they have spent money they didn’t have to keep up with their friends and avoid FOMO.1
Credit cards provide us instant gratification of buying a product or service right away and delaying the payments. However, if you aren’t careful, the debt can pile up faster than you are able to pay off. According to a recent study by Equifax, Canadians aged 18 and 25 have an average of $8,333 in debt.2
How do credit cards work?
A credit card is a card issued by a financial institution or financial service company that lets you buy items or services "on credit." Paying with a credit card means you get the item immediately without having to spend your money at that moment. Instead, the credit card provider pays the seller when you purchase the item, and you repay the credit card provider later.
If you don’t pay off your monthly bill on time or make only the minimum payments required, you will be charged interest on the balance on your account. Interest can quickly drive up the cost of whatever you are buying and end up costing you a lot more than if you paid for the item using your savings.
Take, for example, purchasing a $650 television using your credit card with a 19.99 per cent interest rate.
If you paid $50 per month, you would pay off the balance in 15 months. The interest paid over that time would equal an extra $89 above your purchase price. If you simply made the minimum payment each month, it would take you a whopping eight years and three months to pay off the television. The interest paid would equal an extra $553 and your TV might not even work after eight years!
Risks and Rewards
A credit card may be helpful in establishing a good credit report. If you use your credit card to make purchases and pay off the balance in full each month, it signals to lenders you are a responsible borrower and increases your credit rating. Lenders consider your credit report when you apply for other loans, like a mortgage or car loan.
Many credit cards offer bonuses or perks when you use them. These can include loyalty rewards, cash back options and points to purchase goods and services, like air travel and groceries. Although these perks may seem like a great deal, it’s important to factor in the true cost of the rewards. If you use your credit card enough in one year to earn $500 worth of free products, but you are paying $1,000 in interest to earn the rewards, your rewards aren’t free after all.
It’s important to use credit responsibly, borrow only what you can afford and make payments on time. If you miss a payment, you may be charged a late payment fee, your interest rate may go up, and you may damage your credit report.
Occasionally, your credit card company may offer to increase your credit limit. Keep in mind that just because you qualify to borrow a certain amount doesn’t mean you can afford it – or need it! Borrowing beyond your means and making late payments can have long-lasting negative effects, like when you are trying to buy a home or a new car. Lenders may not be willing to approve a student loan for your education, a car loan or a mortgage if you don’t pay your credit card bill on time or often make late payments.
What to consider before applying
When choosing a credit card, make sure you pick the one that is right for you. Some things to consider include:
- Selecting a card with no (or a low) annual fee. Ask if the card you are considering has an annual fee and if so, what does it cover?
- Comparing the interest rates. Many cards start with a low “introductory” interest rate that increases dramatically after the first few months.
- Researching the insurance and warranty coverage. Credit cards may have extended warranties and insurance options on the products and services you buy with the credit card. Read the fine print and ask questions about what may or may not be covered.
Remember, your interest rate may include additional fees, which is important when you are figuring out the true cost of credit. Ask questions and fully understand the total cost before committing to a credit purchase. In New Brunswick, the Cost of Credit Disclosure and Payday Loans Act requires the creditor to tell you up front about all the costs you will be charged when you apply for a credit card.
Before you swipe your credit card
Give yourself a cooling off period: If you don’t have the money to make a purchase, ask yourself if you really need the item before buying on credit. Walk away and give yourself time to consider the purchase.
Know your limits: Keep in mind, just because you qualify to borrow up to a certain amount doesn’t mean you can afford it or need it.
Have a plan to pay off your debt BEFORE you make a purchase: Know how much time it’ll take to pay off the credit amount, and where that money will come from in your budget. Some credit companies offer no interest, no payment options. Remember, if you don’t pay your balance in full within the predetermined time frame, you may have to pay ALL the interest charged, regardless of the balance left owing.
Think about the lifespan of a product before you buy: If the item you purchase has a one-year life but will take two years to pay off, you will likely have to replace the item before you’ve finished paying for it.
Always read your contract: If you decide to make purchases with credit, it’s important you know the following:
- What is the interest rate you are being charged?
- How long will it take to pay off the debt? (paying a set amount each month, paying only the minimum payments)
- What is the total cost of credit? (The difference between paying in cash and paying on credit)
- Is there a grace period? (The amount of time you have to pay off your bill without being charged interest)
- What are the penalties if you make a late payment or miss a payment?
- When are my payments due?
The Financial Consumer Agency of Canada (FCAC) has a Credit Card Payment Calculator you can use to see how much it will cost to borrow and how long it will take to pay off the debt.