Choosing the right type of card is important to get the most out of your finances, make sure you understand the differences.
In recent years, the number of ways available to spend your money has increased dramatically. While many new options are available, including Venmo, Square Cash, Google Pay and Apple Pay have started to make completely digital payments more common, the vast majority of payments still happen with physical credit and debit cards.
While credit cards and debit cards may look similar, there is a fundamental difference between the two, and it's important to understand the benefits of each.
What is a Debit Card?
Debit cards are the closest you'll get to carrying around cash with you all the time, but in the form of a card. This is because when you swipe with a debit card, you are paying with funds straight out of your bank checking account. The transaction is sent to the bank and then the funds are transferred to the merchant’s account.
To securely use a debit card, you will have a PIN that protects the use of the card, although it may not be required if the purchase is under $25, or if your card has the ability to be processed as a credit card.
Debit cards rarely have annual fees and no interest charges (as long as your bank account balance remains above zero), and can help slipping into debt. These are some of the best benefits to using a debit card – they make it difficult to spend money you don't have, effectively keeping your spending under control.
With most checking accounts, there is no application necessary to apply for a debit card, since it's just a way to access your money more conveniently than an ATM. The most prominent requirement is that you have a checking account with minimum funds in it.
If you do happen to need access to your cash, a debit card makes it easy to withdraw cash – most debit cards also act as your ATM card, but you can also ask for "cash back" when making a purchase. For example, if you make a $10 purchase at a grocery store, and select the option for $40 cash back, your account will be charged $50 and the cashier will open the register and give you $40.
While a debit card is considered a useful tool to limit your spending, there are some ways you can get into trouble if you aren't careful. Accounts that offer overdraft protection will let you spend more than you have in your account – and you'll accumulate fees and debt for the overage if you do, just as you would with a credit card. You would then have a negative balance in your bank account and very likely have to pay fees. To avoid this, all you need to do is keep track of your spending to not overdraft.
Another drawback of the debit card is that it doesn’t help improve your credit score and still has less protection than a credit card, since it still is attached to your bank account.
What is a Credit Card?
A credit card works by being able to purchase everyday things on a line of credit. Consumers are given a limit on their card depending on their finances but can increase the loan with time and a great payment history.
The benefits to having a credit card can be substantial if used correctly. There is an opportunity to build credit, get a big sign on bonus, and earn rewards for your purchases such as cash back or travel credit. Most credit cards offer rewards in the form of points for each purchase, and if enough points are accrued, they can be used towards purchases resulting in free things such as travel accommodation, flights or even just extra cash into your account.
Credit cards also have protection against credit card fraud and increase your purchasing power as they are not linked directly to your checking account. You aren't responsible for unauthorized purchases if your card is lost or stolen.
Most people have a credit card today for the convenience of tracking their spending as well. Your statements make it easy to review how much you have spent on each purchase, and even have year-end statements that summarize your spending over the year. This can be helpful for anyone that wants to keep track of their finances as well as for tax purposes.
Credit cards make it easy to pay for a purchase today and then make payments toward the purchase as you are able. This works if you are in the grace period and don't have to pay interest. Even if you do have interest, you still have until the end of the billing cycle to pay off your purchase until the interest applies.
These rewards can vary by the card issuer and type of card.
However, there are downsides as well, so before swiping with a credit card, here are a few things to consider.
While some credit cards have a grace period of no interest, eventually all credit cards will charge a high interest on your purchases if they are not paid in full every month. Since credit cards are easy and convenient to use, many consumers overspend to the point where they are not able to pay off the full balance each month, therefore accruing more debt that they have to pay off.
The same way that they can build credit, they can also hurt it if not used carefully. If using a credit card, it’s important to budget wisely for all purchases and not more than what you are able to pay off.
Much like a debit card, there is also the chance for an overdraft with the bank. While credit cards offer a convenient way to your bill each month in the form of an automatic payment, if you don’t have enough funds in the bank, it's possible your automatic payment will overdraw your account. The bank will make the payment but it will charge an additional fee which can add up with all the other fees that credit cards charge including interest and annual fees.
In all, if you have a poor credit score, it can be difficult to be approved for a credit card. Some credit cards are specifically designed for people who have filed for bankruptcy, or those with bad credit, but the benefits are typically less attractive. Some of these cards will require you to provide a security deposit until you can prove you can use the card responsibly.
Before deciding on which card is right for you, consider the pros and cons of each card. With both cards you have protection and can report your card missing in a timely manner to prevent others from being able to use it. They also both offer a certain convenience and make it easy to pay for all of your purchases. When trying to determine whether to use a credit card or debit card, be honest with yourself on how you handle your finances. The best card will help you reach your financial goals.
