Shop at any major retailer in the country, and, unless you're using cold, hard cash, you'll be asked the question, "Debit or credit?" If, like me, you typically answer based on the whim of the moment, you'll be interested to know that there really are times when choosing one over the other can make a difference.
Most folks already know the major difference between debit and credit cards, of course. Debit cards immediately withdraw money from an account in which you have previously deposited funds. When you indicate you want to pay with a debit card, the store is checking to make sure you have proper funds in your account. Pay with credit and the merchant simply verifies that you have an adequate credit line, the bank pays at the moment of purchase, and you're responsible for paying them back.
Still yet, there are cards that are a hybrid between debit and credit, requiring a PIN for debit transactions and a signature for credit. The credit portion kicks in if you overdraw your account, to prevent you from getting denied a purchase. Sound good? Banks like to describe this using terms like "emergency cushion," but what it can mean is that what was once your checking account is now a credit card obligation with all the possible pitfalls attached.
Out of these choices, "debit" is the answer stores prefer to hear. The reason? Purely economic. Merchants must pay a percentage of a credit card purchases (typically 2.49%), which can translate into a tidy sum (and a boon for the credit card company), whereas they pay only a flat fee for their customer's debit transactions.
But what about what's best for you? That's not such a simple answer. Each method of payment has advantages and disadvantages. Check the pros and cons list below to determine which option is the right one for you.
- Credit cards are a surefire way to build up credit.
- Your card may offer perks in the form of cash back, airline miles, or other rewards.
- Credit cards may afford greater consumer protection since purchases are covered under the Fair Credit Billing Act. This allows you the option to withhold payment when you are dissatisfied with a purchase.
- You may rack up interest and late fees.
- You can spend much more than your means.
- Your credit rating can be hurt by late payments.
- You don't have to worry about interest or late fees.
- Choosing debit over credit can help you limit your spending.
- A PIN-based debit card can offer you greater security than a signature-required card. Let's face it: Store clerks aren't experts in handwriting analysis.
- Your bank may charge you a point-of-service (POS) fee every time you use your debit card. These fees, while typically a dollar per transaction or less, can really add up.
- PIN purchases do not count toward reward programs like airline miles or education credits.
- Your purchases are not protected under the Fair Credit Billing Act. Similar to when you purchase an item with cash or a check, you could be stuck trying to negotiate directly with the merchant if you're unhappy with a purchase or want a refund.
- Every time you use your debit card, you give out access to your checking account.
- You may have to maintain a minimum balance.
Hybrid Debit/Credit Cards
- You won't have to worry about being denied a purchase because there's not enough money in your account. There's only the cap set by that pesky credit limit.
- You have fewer cards to carry.
- Hybrid cards can make you especially vulnerable to theft since, simply by signing your name, a thief can remove money directly from your account. While both MasterCard and Visa have extended their zero-liability protection to debit card users, this move was voluntary and is therefore subject to change. Debit purchases are still not covered by the Fair Credit Billing Act.
- You may be surprised by the monthly bill and interest charges that kick in when you've dipped into the credit line on your account.
- Your credit rating can be hurt.
- You miss out on lessons of deferred gratification. The credit card portion of your card kicks in before you experience any problems from overdrawing your account.
So when you're reaching for your wallet, what should you remember? Debit cards are great for small, everyday purchases. For large purchases, services like automobile repair and home improvement, and items ordered online or for future delivery, a credit card is the way to go. As for those hybrid cards? While banks tout these as "the best of both worlds," you may be better off being a purist. Keeping your credit card separate from your debit card allows you to maximize the benefits of each.
This article is adapted from the Motley Fool GreenLight "Money Answers" archive, which features more than 100 articles on personal finance topics from taxes to credit to beginning investing, organized by subject and life stage. For access to this content plus the current newsletter, back issues, members-only discussion boards, and advisor blogs, take a free 30-day trial to GreenLight today! MasterCard is an Inside Value recommendation.
Fool contributor Elizabeth Brokamp writes a weekly column, Ask Mrs. Riches, on money and relationships. Her charming other half is The Motley Fool's own Robert Brokamp (TMF Bro), editor of Rule Your Retirement.