Cash and checks are becoming a thing of the past, and debit cards are largely what's replacing them. Understanding how debit cards work and their pros and cons versus credit cards is crucial to navigating today's financial landscape.
A debit card is a card payment method, similar to a credit card. Your debit card pays for purchases by immediately withdrawing money from your bank account. By contrast, credit cards borrow money (which you pay back later). You can also use a debit card to withdraw cash from your bank account at an ATM. Debit cards are issued by most financial institutions that offer checking and/or savings accounts.
Debit cards are a quick and convenient way to pay for everyday purchases. Before opening your first debit card, it's important to understand the benefits and drawbacks of paying via debit card.
You don't need good credit, or any credit at all, to get a debit card. Unfortunately, this also means that debit cards don't help you build credit. They also don't usually come with rewards or extensive benefits. Additionally, debit cards don't offer as much fraud protection as credit cards.
You don't run the risk of falling into debt with a debit card. Each purchase is immediately paid in full through your checking account. However, if you ever need to pay off a purchase over time, you don't have that option with a debit card. You always have to pay for your purchases right away.
There are sometimes fees associated with debit cards. These might include an overdraft fee or a checking account monthly maintenance fee. The good news: these tend to be low-cost or free.
Sadly, there are still barriers to opening a bank account, and therefore a debit card -- particularly for immigrants, the homeless population, and those living in poverty. Not everyone can get a debit card. Hopefully, in the future, some of these barriers will be removed.
Debit cards use money you already have to pay for purchases -- credit cards borrow money and pay it back later.
Credit cards can be convenient when you don't have enough money saved up to pay for a purchase all at once. However, failing to pay off your credit card in full each month leads to expensive interest charges. You don't need to worry about those charges with a debit card.
When you pay with a debit card, a payment processor (like Visa or Mastercard) moves money from your checking account to the merchant (whoever you're paying). This is different from paying with a credit card. When you use a credit card, the payment processor transfers money from the card issuer to the merchant. Then, you pay the card issuer back over time.
Your debit card may have the Visa or Mastercard logo on the front, just like your credit card -- but with your debit card, you pay for your own purchases upfront out of your bank account.
There are a few advantages credit cards have over debit cards. They're worth it if you make sure to pay off your bill each month and avoid interest fees:
These are some terms you should be aware of when using a debit card.
Checking account: A checking account is a bank account that's used for everyday needs, such as receiving income and making purchases. Your debit card is typically linked to a checking account.
Savings account: A savings account is meant to be used for money you plan to save rather than money you plan to access regularly. While savings accounts still give you immediate access to your funds, Federal Reserve Regulation D limits savings accounts to six "convenient" transactions per month.
Personal identification number (PIN): A PIN is a confidential code you set up upon opening a debit card that provides an extra layer of security when processing transactions.
Debit card number: Your debit card number is the 16-digit number found on the front of your debit card.
Account number: Your account number is a unique number associated with your bank account, and is typically 10 to 12 digits long.
Routing number: Your routing number is a nine-digit number associated with your financial institution. You can find this number on the bottom of your checks, or by contacting your financial institution.
Card verification value (CVV): This is a three-digit code (four digits in the case of American Express cards) printed on the back of your debit card used to provide additional security for online purchases.
Automated teller machine (ATM): An ATM is a machine where you can use your debit card and its associated PIN to withdraw cash from a linked bank account.
In-network and out-of-network ATM: Financial institutions have their own networks of ATMs. Using an in-network ATM is often free. Out-of-network ATMs are those operated by other financial institutions. You might be charged an ATM fee by the other financial institution, your own financial institution -- or both -- for using an out-of-network ATM.
Direct deposit: Direct deposit is when you set up incoming payments, whether it's paychecks from your job or other forms of income, to be deposited directly into your checking account (rather than sent in the form of a check).
Overdraft: When you overdraft your bank account, you've used your debit card to pay for a purchase that costs more than the money you currently have in your account. Sometimes these transactions will be denied. If they go through, it's called an overdraft. You'll have to pay back the overdrafted funds and any associated fees immediately.
Overdraft protection: Some bank accounts offer overdraft protection. This is a service that allows you to connect a back-up source of funds such as another checking account, a savings account, or a credit card. In the event that you overdraft your primary checking account, the additional funds will be pulled from your back-up account.
Overdraft fee: Most banks charge an overdraft fee when you charge more to your account than what's available. The average overdraft fee is $35.
Foreign transaction fee: Some debit cards charge a fee for every purchase you make in a foreign country. The typical foreign transaction fee is 3%, meaning you're charged a $3.00 fee for every $100 you spend while abroad.
There are a few different types of debit cards. It's important to understand the difference when deciding which one is best for you.
Until the last few decades, cash and check were the most popular payment methods in the United States. Debit cards were introduced in the 1980s as ATM cards. At that time, most consumers used them only to withdraw cash from their bank accounts at an ATM rather than to make purchases.
It wasn't until the mid to late 1980s that merchants started to acquire point of sales (POS) systems that accepted debit cards as a form of payment. They weren't widespread as a form of payment for purchases until the early 1990s, when debit cards finally received Visa and Mastercard logos. This development allowed consumers to use Visa or Mastercard-branded debit cards at any merchant that accepted Visa and Mastercard credit cards. By the late 1990s, debit card purchases outnumbered check purchases.
Debit cards are one of the most widespread and convenient forms of payment. While they don't build credit or offer generous cash back or travel rewards, and they aren't quite as safe as credit cards, paying with your own money can provide a safety net to avoid debt.
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