Question

1. Wei is in his first year at Concordia and is aware that credit card companies target university students. He is ready to apply for a credit card but sees that there are many comparators in terms of interest rate, reward points etc. The two companies that have made him credit card offers are the Royal Bank with a nominal interest rate of 23.8%, while CIBC’s effective interest rate is 26.86%. Wei also knows that the interest rate on credit cards is compounded daily (365 days), two decimal places. Which statement is false?

1. Credit card interest is charged when you don't pay off your full balance by the due date each month.
2. Cash advances can also negatively impact your credit score by increasing how much money you’re borrowing relative to your overall credit limit, also known as your credit utilization rate. Generally speaking, you want to limit your overall borrowing amount to get a good credit score, which may be a harder target to hit if you suddenly withdraw a large credit card cash advance.
3. Interest charges on cash advances kick in immediately with no grace period.
4. Both credit cards (Royal Bank and CIBC) have equivalent effective interest rates.
5. The CIBC’s credit card interest rate is higher than the Royal Bank’s credit card interest rate when comparing effective interest rates.

Answer 1

Statement (e) is false. The following arguments are to be noted:

a)This is a correct statement. Interest on credit card is charged only in non repayment of full amount due by the due date each month.

b) This is a correct statement. Banks closely monitor your credit utilisation month on month. Incase your repayments are timely and you utilise a decent proportion of your credit limit, there is a positive response to your credit score. Cash advances can also negatively impact your credit score by increasing how much money you’re borrowing relative to your overall credit limit.

c) This is a correct statement. Withdrawal of cash amounts against credit card attracts interest immediately. Hence it is advised not to withdraw cash against the credit card.

d) This is a correct statement. The interest rates for Royal Bank is a nominal 23.8%, while CIBC’s effective interest rate is 26.86%.

Converting Royal Bank's nominal 23.8% into effective we get:

1+i* = (1+ (i/365) )^365

where i* is effective rate and i is 0.238.

1+i* = 1.268610795
i* = 0.268610795
which is approximately equal to effectve interest rate of CIBC.

e) This is a false statement. The interest rates for Royal Bank is a nominal 23.8%, while CIBC’s effective interest rate is 26.86%.

Converting Royal Bank's nominal 23.8% into effective we get:

1+i* = (1+ (i/365) )^365

where i* is effective rate and i is 0.238.

1+i* = 1.268610795
i* = 0.268610795
which is approximately equal to effectve interest rate of CIBC.

Hence CIBC’s credit card interest rate is not higher than the Royal Bank’s credit card interest rate when comparing effective interest rates.