Credit Cards vs. Debit Cards: A Guide

Understanding the functions of credit cards and debit cards is an important aspect of managing our personal finances with skill and creativity. The primary difference between these two financial tools is that debit cards draw directly from your personal bank account and credit cards basically use money that you have not earned yet, which you can use to make purchases and pay back slowly over time at a cost.

So why on earth would anyone want to pay a lender extra money to make purchases on a credit card when it would be cheaper to make purchases directly from our own funds by using a debit card? The answer to that question varies from one consumer to the next, but statistics show that over 45% of American households carry some form of credit card debt.

Is it a good idea or a bad idea to use credit rather than debit? It depends on your personal financial beliefs and goals. Like any other comparison between two sides of an issue, there are going to be advantages and disadvantages to both sides.

Pros and Cons of Paying by Credit Card

Paying by credit card gives some consumers a sense of security by keeping more available cash in their personal bank accounts. While that might be true at the moment of purchase, it doesn’t hold up so well in the long run at 17-23% in monthly interest charges and fees on a credit card if you don’t pay it back right away.

At the average rate of 20.28%, a $5,000 balance on a credit card can take up to 30 years to pay off and total over $23,000 by the time it is paid. That’s assuming new charges haven’t occurred, which would increase the time frame and total payoff amount.

Another item to consider is that more credit card debt can lower your credit score. If you are planning to buy a home or apply for any types of personal loans, the most ideal situation is to have lines of credit open and available while having the balances paid down to zero. The standard that most creditors like to see when they lend money is 30% usage or less.

On the other hand, if you can manage your debt carefully and pay it off quickly (monthly is ideal) to avoid interest, it is a good way to build a solid credit history and increase your credit score. Many credit card companies offer free credit score monitoring for their account holders as well as additional warranties and protections on consumer purchases.

There are some other advantages to using a credit card for large purchases and online purchases.

Fraud Liability

Credit card companies protect their consumers from any liability for charges, interest, or late fees on purchases that have gone wrong or that were initiated by someone who shouldn’t have access to their credit card number. In fact, the Fair Credit Billing Act prevents credit card companies from holding you responsible if there are unauthorized purchases on your card!

Refunds

When you request a refund on a credit card purchase, you won’t be getting “cash” back for your purchase. Instead, you’ll get a “credit” on your account. In other words, you’ll see the total from your return subtracted from the amount you owe to your credit card company. This can work in your favor or can be frustrating if you were hoping to have those funds land in your bank account, so keep that in mind when making big purchases!

Rewards

Have you heard of frequent flier miles and cashback rewards that come with some lines of credit? Keep in mind, though these rewards can be nice, if you’re not paying your credit card bills promptly, they may not be worth it. A “free flight” that would cost $200 in cash on a debit card could cost a few thousand in credit card interest over a long period of time when it is added up – but if you pay everything back at the end of the month (rather than just making your minimum payment), you won’t owe any interest and the rewards will be complete gains.

Overall, using a credit card can be convenient and it can provide a sense of security knowing that you are free of liability for charges and fees that are in question. But, the biggest difference between credit cards and debit cards is that credit cards can be extremely expensive in the long run if you don’t pay them back immediately. In addition to interest on a monthly basis, there are often annual fees, overage fees, late payment fees, and penalties that can make it difficult to see the monthly balance get smaller. In fact, by making the minimum payment rather than trying to pay large portions of the balance on a credit card, the monthly balance can stay the same or increase depending on all of the fees and interest rates.

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Types of Credit Cards

If credit cards are a good fit for you and your spending habits, there are several types of credit cards to consider.

Standard credit cards generally have either a small annual fee or no fee at all. They are good for small purchases, balance transfers, and/or cash advances. These cards will also help you build a credit history, which will help you apply for other lines of credit and loans.

Premium credit cards provide additional perks like concierge services, airport lounges, special event access (concerts, advance product orders, or VIP sections at events). All of this is provided to take the sting off of the high interest rates and annual fees that usually come with these premium cards.

Rewards cards give consumers travel points and cashback rewards that they can apply to their monthly balance or transfer directly to their personal bank account. The cashback amount is usually less than the amount of interest that is paid for the same month.

Balance transfer cards are cards that offer a low introductory interest rate and low fees when used to transfer a balance from another card. There is usually a deadline for the low interest rate and at that point, if the transferred balance has not been paid off, you’re back to paying high interest rates once again.

Secured credit cards are backed by a customer’s cash deposit into a checking account as collateral. These types of credit cards are good for someone who is just starting to build a credit history and cannot get approved on a credit card application. By securing your own line of credit, you can borrow money against your own secured money, pay off the balance each month and establish a positive credit history of making payments on time over an extended period of time.

Pros and Cons of Paying by Debit Card

Using a debit card is convenient because purchases can be made just about anywhere and the funds come directly out of your personal checking account without the need to carry cash. However, convenience can also make it easy to overspend because most people tend to spend more slowly if they have to part with cash.

Generally speaking, debit cards make everything easier and eliminate the need to go to the bank to withdraw money for the day or week ahead. If you really need cash, debit cards can also be used at any store to get cash back at the end of your transaction. You also won’t owe any interest on debit card purchases, since the funds come directly out of your bank.

Debit cards have also made paper checks a thing of the past. There is no need to write a check, put it in the mail and pay your bills by the old “slow boat” method. Debit cards can be used over the phone to pay utilities, car payments, and credit payments. They can also be stored in your favorite accounts like Amazon to make purchases with one click.

For small purchases, it makes a lot more sense to use a debit card rather than a credit card, because you don’t want to pay interest on a $3 purchase. Using a credit card to make larger purchases and pay for the purchase in smaller and more manageable chunks makes more sense. It is easier to justify paying interest fees for a loan to purchase something you might not have the cash for. However, if you pay your full credit card bill at the end of every month, it’s ok to pay for small purchases with that card because you won’t ever owe interest on it. In fact, it will help you build good credit.

Debit cards are the best choice for those who want to avoid additional fees and piling up debt. The only fees to be concerned about when using a debit card are overdraft fees or ATM fees when using a non-affiliated ATM from another bank or vendor- like the ATMs you might see at a local convenience store.

Types of Debit Cards

There are fewer types of debit cards than credit cards.

Standard debit cards are your basic debit cards that are connected with your personal checking or savings account. These are used for direct purchases without any interest or fees attached.

EBT cards are issued by state and federal programs and are designated for individuals and families that need assistance with food and other necessities. They are used the same way a standard debit card is used and there is an established monthly budget allowed for use. The cards are replenished at the same time each month until the family or individual no longer needs assistance.

Prepaid debit cards are useful for anyone who doesn’t have a bank account but doesn’t want to carry cash. By depositing funds onto the card through a service provider, the cardholder could use the card to make purchases up to the amount available on the card.

Paycards are similar to prepaid cards except that they are usually “loaded” by your employer. These are usually issued by employers as an alternative to paper checks. You would receive your paycheck on your paycard and be able to use it as a debit card.

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When to use Credit vs. Debit

Choosing which type of card to use comes down to a couple of basics. Are you making a small purchase or a large purchase? Do you need added protection in the event of cancellation, refund, or vendor fraud?

Debits are the best option when it comes to recurring, daily expenses. Groceries, gas, monthly payments, and small purchases are much easier directly from your personal checking or savings. If you don’t have a card at all yet, you will want to start with a debit card from an FDIC-insured bank.

Credit cards are the way to go when it comes to hotels, car rentals, airline tickets, dining out, or any type of purchase that is subject to any sort of dispute.

If you find that you are struggling to pay your credit card bill or generally struggling to make it from paycheck to paycheck, try using Rain (if your employer has signed up). Rain works by connecting to employer payroll and timekeeping systems to allow you early access to your earnings (no more waiting for payday)! If your employer has signed up for Rain, download the Rain app and create your account today!