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Why Credit Card Interest Rates are High

By Debt.ca on November 10, 2020 No Comments
man upset about his credit cards

Today you can get a 5-year fixed-rate mortgage for under 3 per cent and a secured line of credit for as little as 3 per cent, so why are credit card interest rates still so outrageous? With a typical interest rate of 18 per cent, credit cards are one of the most expensive forms of debt next to payday loans. Strive to avoid carrying a balance at all costs. Carrying a balance can take you years to pay off and cost you thousands in interest. Although credit cards are a form of consumer financing, there is little relation between your credit card’s sky-high interest rate and the prime rate.

The Overnight Lending Rate and Credit Card Interest Rates

There is little relation between the overnight lending rate and credit card interest rates. The overnight lending rate set by the Bank of Canada represents less than one per cent of bank funding, says the Canadian Bankers Association (CBA). In fact, the CBA says it in no way influences the pricing of consumer lending or credit card interest rates.

What affects credit card interest rates?

If the Bank of Canada doesn’t influence credit card interest rates, who does? According to the CBA, there are several factors that influence credit card interest rates and fees, including:

Grace Period:

An interest-free period from purchase to payment, depending on the card, as long as the balance is paid in full when owing.

By paying off your balance each month, you’re receiving free short-term financing from your credit card issuer. For those who don’t pay their balance, issuers recover some of the costs through high interest rates.

No Collateral:

Access to unsecured credit where no collateral is needed makes it a higher risk for the credit card issuer.

The interest rate on a consumer product has a lot to do with the risk to lenders. Mortgages come with such low interest rates because they have a home as collateral. With credit cards, there is no security, so the risks of default are a lot higher.

Processing Costs:

There are significant costs to operating the credit card system, including processing a large volume of transactions, the technology that is constantly updated to support transactions, preparing and mailing statements, collecting payments, and the costs for providing value-added rewards programs.

Although purchasing with your credit card is free in most cases (unless you pay an annual fee), retailers foot some of the bill. Retailers are charged a transaction fee for every purchase. With new security advances like Chip-and-PIN technology, again, it’s the cardholders who don’t repay their balance in full that help share the cost.

Fraud Prevention:

Costs to fight fraud and customer reimbursement. When fraud occurs, customers have zero liability. In 2013, financial institutions reimbursed more than $465 million to their Canadian credit card customers. 

Despite security advances, fraud is a growing problem with credit card issuers. In 2013, over 693,000 accounts were the victim of credit card fraud. Although you’re most likely covered by zero-liability protection, it’s the delinquent cardholders that help pay some of the losses.

With a better understanding of interest rates, you can avoid incurring high fees.

 

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