A subscriber to the Courrier de l’Économie wondered why credit card rates were not decreasing after recent reductions in the key rate. The answer has come, and it encourages us to look beyond the rent of money required.
It is generally recognized that the change in the interest rate on credit cards is asymmetric, with an upward bias. Moreover, many financial institutions increased their rate from 19.99% to 20.99%, or even 21.99%, in the first half of 2023, amid a rise in the Bank of Canada’s key rate. But now that the central bank has committed to monetary easing…
Certainly, there are cards on the market with (lower) interest rates. The Canadian Bankers Association (CBA) talks about more than 30 cards offered with an interest rate lower than 13%. We are talking about rates ranging from 12.99% to 15.99%, compared to 19.99% and more for traditional cards (or even 29% on a department store card), we read on the Ratehub site.
These cards also charge a better rate on balance transfers and cash advances, and their required annual fees are often minimal. However, on the other hand, most of them do not offer rewards points or insurance coverage, extended warranty programs or other “privileges”. And what is a so-called active user looking for? To accumulate points and cash back.
See beyond the rate
In 2009, the federal Minister of Finance led a small foray into credit card territory. Consumer associations would have liked him to take the opportunity to impose a ceiling on the difference between the required rate and the preferential rate of financial institutions. Nenni. He preferred to rely on the industry’s argument that Canadians benefit from sufficient choice within the financial system.
(Small consolation: while the gap between the prime rate and that charged on unpaid credit card balances was more than eight times in January 2022, it recently fell below three times. But it’s under the blow of a preferential rate multiplied by almost three.)
This parenthesis being, two years later, the Quebec Minister of Justice tabled a bill which also avoided addressing the level of rates, but which focused on debt. It included among its flagship measures – and fully justified – the gradual increase, from 2% to 5%, at the rate of 50 basis points per year, of the minimum monthly payment. It was unanimously adopted by the National Assembly in November 2017 and entered into force on 1er August 2019.
Thus, the percentage of the minimum balance to be paid each month increased from 4% to 4.5% on 1er last August for any contract concluded before August 2019 (the percentage of 5% is already in force for any contract concluded since 1er August 2019). The Consumer Protection Office pointed out that with a minimum payment of 2% of the balance in 2019, for purchases of $1,000 with a card with a credit rate of 19.9%, it would take the consumer more than 25 years sticking to the minimum monthly payment to repay his debt, paying interest costs of around $3,000. With a minimum payment set at 4.5% of the balance, the same debt will incur credit charges of just over $500 over some seven years.
In 2025, the percentage will reach 5% for all credit cards. According to the calculator of the Financial Consumer Agency of Canada, always sticking to the minimum payment, with a rate of 5%, the repayment of a balance of $1000 on a card with the credit rate is 19.9% spanning six years with an interest expense of $442. We can see the full impact of this measure and the use of compound interest on debt.
Zero interest rate
As for the high level of the contractual rate… We generally assume that, roughly, 70% of cardholders pay their balance in full each month. This percentage may certainly imply for some people to use their personal line of credit, which commands a lower rate than that of a credit card or a personal loan. However, for this 70%, the interest rate is zero for the credit card. Not to mention that the interest-free period can stretch to 51 days from the time of purchase to the time of payment if the balance is paid on maturity.
We can read on the ABC website that in Canada, the majority of consumers use credit cards as a means of payment rather than as a loan. Moreover, for a longer-term loan, it is advisable to explore lines of credit, personal loans and consumer loans. As a method of payment, the debit card has a role to play in the same way as cash, or even checks.
Among other consumer benefits, a credit card is a convenient payment tool accepted in more than 200 countries. It takes the form of an unsecured loan (therefore considered higher risk by financial institutions). More precisely, it provides access at all times to unsecured credit and, it bears repeating, to interest-free payment between the date of purchase and the end of the billing period. It offers a purchase guarantee if the item is damaged, stolen or not delivered within 90 days. In the face of fraud, there is zero liability. At least, the consumer is protected by two laws governing situations where a transaction is not authorized.
For retailers, we are talking in particular about fast and guaranteed payment. A possibility of accepting credit payments without worrying about the solvency of their customers, insufficient funds or payment delays. Or even a reduction in costs and time handling cash. As for the inherent fees paid to the issuing institution, they are generally included in their prices and passed on to consumers.
It’s defensible.