While choosing to swipe your debit card or credit card may seem arbitrary, there are significant differences in how they work, their benefits and their potential drawbacks. Knowing what happens “under the hood” when you make a purchase can help you save money and lead to better financial habits.
Here’s what to know about how credit cards and debit cards differ — and which one to use when making a purchase.
[See: 8 Ways to Maximize Your Credit Card Rewards.]
Debit cards. Issued by your bank, a debit card draws directly from your checking account. It allows you to withdraw cash from ATMs and at point of sale (for example, getting $20 back when you pay at the grocery store). Like when you withdraw from an ATM, when you make a debit card transaction, the money is pulled instantly from your checking account.
Using a debit card can help you limit spending and stay on a budget. Purchases are capped by the amount of money in your account, keeping you from spending money you don’t have (assuming you haven’t opted into overdraft protection), building debt and paying interest fees. Using a debit card will not build your credit history.
Because debit cards draw directly from your bank account, if your card gets stolen or lost, you will be out the full amount of any fraudulent charges until the matter is resolved, and reimbursements can take weeks. The Electronic Fund Transfer Act, or EFTA, covers fraud protections for debit cards. If you catch the fraudulent charge within two business days, you will be responsible for up to $50 of the total amount. If you catch it within 60 days, you will be responsible for up to $500 of the fraudulent charges. After that, you won’t be able to get any of the fraudulent charges reimbursed.
Using debit as credit. If your debit card is a Visa or Mastercard, you can use it like a credit card. At the register, instead of typing your pin, you’ll sign to complete the transaction. Unlike when you use debit, when you choose credit, the purchase amount isn’t drawn from your account immediately. It can be a few days before the issuer processes the purchase and withdraws the money from your account. Also, using debit as credit doesn’t help you build credit.
One benefit of using debit as credit is that you will have better protections if you have fraudulent charges, with some bank cards offering $0 liability guarantees and next-day reimbursements. Not all banks offer the same coverage, so you’ll have to check your account agreement to see what is covered.
Credit cards. With brands such as American Express, Visa, Mastercard and Discover, credit cards allow you to draw against a predetermined line of credit. You will have around 30 days to pay off all charges made each statement period. If you are unable to pay off the full amount, you can pay a smaller minimum amount on your due date, but you will pay interest on the unpaid balance until you pay it off.
Credit cards offer consumers the chance to earn rewards on purchases, such as cash back or miles, and paying your credit card bills on time helps build your credit history. Credit cards can also offer benefits such as purchase protections, extended warranties and price protections.
Unlike debit cards, credit cards pull from your credit line, so the money in your bank is safe from any fraudulent charges or while waiting for reimbursements. The Fair Credit Billing Act, or FCBA, covers fraud protections for credit cards. Protections for fraudulent charges on credit cards are stronger than for debit cards, with the law limiting your responsibility to $50. Many credit card companies offer $0 liability protections for fraudulent and unauthorized charges.
Because credit card purchases are not limited to your available funds, you can buy something you may not be able to afford at the time. This can lead to overspending, credit card debt and interest fees. Another drawback is that late bill payments can negatively impact your credit rating.
[See: 12 Simple Ways to Raise Your Credit Score.]
Debit or credit? Debit offers the flexibility of withdrawing cash and can help keep your spending within your available funds. But debit cards don’t offer the protections and benefits of credit cards, even when used as debit for credit. Credit cards offer stronger fraud protections and rewards, but require better budgeting to avoid overspending, building debt or hurting your credit score. Knowing when to use debit or credit will depend on your personal spending habits. Check with your bank and credit card issuer to see what protections they offer.
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Debit Cards Versus Credit Cards: What’s the Difference? originally appeared on usnews.com
