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Credit Card Terminology

Annual Fee
A charge levied each year for use of a credit card. It's billed directly to your monthly statement. However, some credit cards come without an annual fee.

Annual Interest Rate
The annual interest rate charged on purchases that don't benefit from the interest-free period. There is no interest-free period for cash advances or balance transfers, and interest is charged from the day you withdraw the funds.

Balance Transfer
The transfer of an outstanding credit card balance from one card to another, usually between different institutions. The new card issuer usually charges interest from the day the amount is transferred to the new card -- there is no interest-free period.

Cash Advance
The withdrawal of funds from your credit card, up to the credit limit allowed. The amount you withdraw may be subject to daily limits. There is no interest-free period, so interest is charged from the day you withdraw the funds.

Convenience Cheque
A cheque provided by the credit card issuer and drawn on your credit card account. You can use a convenience cheque the same way you would a personal cheque. When you use a convenience cheque, the transaction is treated as a cash advance for the purposes of calculating interest charges - there is no interest-free period and you're charged interest until you pay back the amount of the cheque in full.

Grace Period
The grace period is the time between the statement date and the payment due date, and is determined by the credit card issuer. The grace period usually varies between 17 and 30 days and is part of the interest-free period. The grace period may not apply unless you meet certain conditions.

Interest-Free Period
The interest-free period on new purchases starts on the date you make a purchase and ends when the credit card issuer begins charging you interest on that purchase. The interest-free period includes the grace period determined by the credit card issuer. It may not apply unless certain conditions are met.

Minimum Payment
The minimum amount payable each month on your credit card balance.

Penalty Interest Rate
The rate at which penalty charges are calculated. It only applies to charge cards.

Prime Rate
The interest rate a financial institution charges on loans to its best customers.

Reference Rate
A base rate, such as the Prime Rate, used in the calculations of variable credit card interest rates.

Reward Program
A program offered by credit card issuers that gives cardholders rewards for using their credit card. You collect reward points every time you charge a purchase to your card. You can usually redeem these points in merchandise, travel or cash, depending on the program.

Security Deposit
The amount you deposit with a credit card issuer as security to obtain a secured credit card.

Credit costs: Miscellaneous fees
Some card issuers require an annual fee: the amount you must pay when you obtain a new card, and to renew it every year. Some banks also charge fees for submitting an application, for being late with a payment, for taking out a cash advance, for exceeding your credit limit or for maintaining a zero balance. Read your cardholder agreement carefully so that you know all of the terms and conditions.

Credit costs: Interest
When you use your credit card, you are, in effect, taking a loan out from the issuing bank or financial institution for your purchases. In return for this, the bank charges you a fee. This is called "interest." If you always pay the amount owing on your credit card by the payment due date, you never have to pay interest. In Canada, about 70% of all Bank Card holders pay their balances in full all or most of the time. If you don't pay the amount owing on your credit card in full by the due date, the interest your credit-card issuer charges you will depend on the type of transaction in question: a new purchase, a previous purchase, a cash advance or a balance transfer.

New purchases
New purchases are items that appear on your monthly statement for the first time. Certain conditions can make these purchases interest free for a defined period. Inquire with the issuer of your credit card about the nature of your "interest-free period."

Previous purchases
These are purchases that have appeared on a past statement, but that you have yet to pay off. Interest is charged on these from the date you made these purchases until they're paid for in full. Some credit-card issuers charge interest from the date the purchases are posted to your account.

Cash advances and balance transfers
The issuing bank or financial institution treats cash advances like loans, not like purchases of merchandise. As such, you're charged interest from the date you took the cash advance or made the balance transfer.

Interest calculation method
When your credit-card company calculates the interest you owe, it normally does so with one or two methods: the "average daily balance method" or the "daily balance method".

Average daily balance method
The average daily balance on your credit card is the balance you carried during the billing period, averaged by the number of days in the billing period. Your average daily balance is calculated at month's end by adding the balance at the end of each day, then dividing the total by the number of days in the billing period. To calculate the interest charged for the month, banks multiply the average daily balance by the daily interest rate. Then they multiply the result by the number of days in the billing period.

Daily balance method
This interest-calculation method calculates interest owed at the end of each day of the billing period, versus the month-end-only calculation that is the hallmark of the average daily balance method. To calculate the daily interest charge, banks multiply the daily balance by the daily interest rate and then add up the resulting daily interest charges for a monthly total.

Credit costs: examples of credit card costs
January 5 to January 31 - purchase of $3,000
(no purchases made from January 1 - 4)

Average Daily Balance Method:
$3,000 for 27 days
Daily Balance Method:
$3,000 x (0.05068%) = $1.52
$1.52 x 27 days = $41.05

Calculation of Average Daily Balance
No purchases made from January 1 - 4
Average Daily Balance Method:
($0 x 4 days) + ($3,000 x 27 days) / 31 days in the billing period = Average daily balance of $2,612.90
Daily Balance Method:
Not applicable

Total Interest Charged
Average Daily Balance Method:
Average daily balance x Daily interest rate x Number of days in the billing period = $2,612.90 x 0.05068% x 31 days = $41.05
Daily Balance Method:
$0 + $41.05 = $41.05