The Difference Between Credit Cards and Debit Cards
Credit and debit cards have been staples of the American economy since the mid-1980s. Since their inception, millions of Americans have lifted themselves out of financial hardship by building a workable credit score with credit cards while, unfortunately, many have fallen under the trap of insurmountable debt by not understanding the limits of what credit cards can offer.
The goal of this Money Chat is to help you understand what credit cards and debit cards are, how they are different, what the benefits and drawbacks of each are, and how you can best use them to succeed.
Starting with the simpler of the two cards, debit cards are extensions of a set amount of money. Typically, debit cards refer to bank cards that act as ways to extract money from someone’s personal checking or savings accounts. In addition to standard debit cards, there are prepaid debit cards that allow you to access a prepaid amount of money. These are also called gift cards.
Debit Card Benefits
The benefits of a debit card are very straightforward. Due to the nature of debit cards, you cannot pay for items you do not currently have the money to afford. If your account is at $100, and you’re trying to purchase $200 in goods, your card will simply be declined. Debit Cards are the best natural deterrent to avoiding any outstanding consumer debt.
Because debit cards are usually issued by your bank or whoever holds your accounts, there are certain fraud protections that come with the cards as well. For example, if a purchase is made using a debit card that wasn’t made by you, you can freeze your debit card and call your bank to dispute any charges. With no annual fee to have a card, debit cards also prevent any real risk while maintaining a way to purchase goods quickly without an abundance of on-hand cash.
Drawbacks To Debit Cards
Debit cards aren’t all good, however. Because debit cards are not lines of credit, consumers will not build any credit while using the cards. Because of the lack of risk, there is also very little credit score reward. While many major credit cards offer cash back, miles, or additional rewards for using them, debit cards typically are just like using cash. While using a debit card you gain no added value for each purchase other than helping you not to overspend.
The largest drawback comes from untimely overdraft fees. Overdraft fees occur when you spend or lose more money than you have. If you use your checking account for auto draft bill paying and make lots of purchases in a short amount of time, for example, you could accidentally overdraw your account. If your account balance goes below $0, many banks will charge your account $30-$60 in fees for having to correct your balance. This cycle can be daunting for those just starting to venture into having money in a bank account. Unpaid negative balances caused by overdrafts and overdraft fees can turn into collections accounts if left unpaid. Linking your checking account to a backup Savings or Credit card account is one way to avoid a situation like this becoming too costly, and keeping track of your budget, bills, and balance will help you prevent overdrafts from happening in the first place.
Credit cards are ubiquitous in the United States. Over 200 million Americans have access to at least one credit card and over half of Americans have some amount of overdue credit card debt. But why do so many people use them?
Types of Cards
There are many types of credit cards but 5 main choices the average American will have to consider: a standard, premium, rewards, balance transfer, or charge card. A standard credit card is what you picture. An extended line of credit from a bank that allows you to make purchases and then pay off those purchases over time. Premium credit cards are more involved cards like American Express cards. These typically come with numerous perks like concierge services, special events, access to airport lounges, and more but with the main drawback of an annual fee. Rewards cards have exploded in recent years and include those that provide airline miles, cash back or other flat rewards for using more credit.
Balance transfer cards and charge cards are less common and typically are only used by businesses. Balance transfer cards come with lower fees and interest rates and act as a way to move debt from one card to another. A charge card is a credit card with no credit limit and allows businesses to make massive purchases, but the entire balance must be paid each month.
You can probably already start to see some of the benefits of credit cards, but the primary one is credit history. Credit history accounts for 30% of your total credit score and is vitally important for building a healthy score. In addition to credit history, having at least one line of credit dedicated to a credit card improves your credit variety score as well, which is 10% of your total credit score.
The most recognizable benefit of credit cards is the rewards. Many credit cards come with 1% cash back, additional air miles, or points towards a rewards system that makes using the card more valuable. Instead of using a debit card on a $100 purchase, you can use your credit card and gain $1 back for making that purchase at minimum. This rewards system is the hook for the entire credit card system and is effective at drawing in new customers.
On top of rewards, credit cards also come with many purchase and fraud protection programs. The major banks like Citi, Chase, and others provide purchase protections that allow you to
“charge back” disputes. This means the credit card will refund you for your purchase and issue a charge toward whatever organization you’re disputing.
Because credit cards are so ubiquitous, the entire industry is also heavily regulated against bad faith purchases. Dozens of laws have been enacted that protect American consumers against items that were never delivered, destroyed during shipping, or even defective upon returning home from a box store.
Credit cards, while carrying quite a lot of benefits, also have one major downside—debt. LendingTree found that Americans have $887 billion in credit card debt. Yes, that’s Billion. This insurmountable amount of debt comes from the true fundamental downside of credit cards—it’s unaccountable money. With debit cards, you know exactly how much money remains in your bank. With credit cards, purchases can be made without directly impacting your wallet. While those purchases have to be eventually paid off, they can be ignored for months or sometimes years depending on how you pay down your credit card.
Because of this drawback, credit cards, while providing a massive benefit of building your credit history, can also quickly tank your credit score. If you start to build too much credit card debt, your score will quickly plummet due to overextended credit lines and unpaid accounts.
The last major downside is the confusing nature of credit cards. While debit cards provide an easy-to-understand format, many credit cards have vastly different interest rates and vastly different credit lines. For example, one bank could issue you a credit card at 15% interest with a $3,000 credit line while another may choose to issue you a credit card with 7% interest but only a $1,000 credit line. On top of these discrepancies, many credit cards have different minimum payments. At the end of each month, you must pay a “minimum balance” to keep your account out of delinquency. This balance could be as little as $25 or as much as $1,000 depending on your credit line.
So, What Should You Use?
The answer, like most financial situations, is… it depends. Credit cards and debit cards have vastly different benefits and drawbacks and should be used for different situations. While debit cards can keep you honest and should be used if you struggle with impulse control on unnecessary purchases, credit cards cannot be ignored due to the volume of rewards given for using that credit.
It’s important to explore additional educational resources that can help guide you through a better understanding of which card is right for you. Many banks also offer free consultations if you’d like to speak about credit and debit cards at more length with financial professionals. Whatever you choose to do, make sure you understand the comprehensive benefits and drawbacks before making purchases.
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The information contained in this article is meant to serve as general guidance for consumers and not meant to serve as comprehensive financial advice. For questions about your individual circumstance, finances, or accounts, please contact your creditor(s) and/or financial advisor directly.
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