School doesn’t teach much about how to manage finances. According to Visual Capitalist, only 22.7% of elementary and high school students around the U.S receive personal finance courses. More often than not, many find themselves learning about finance through experience; sometimes good, many times a learning lesson. Knowing the differences between debit cards vs credit cards is a great example of those simple but unanswered financial questions many adults struggle with today.
While both are used to make purchases, they operate differently, so it’s important to understand how they work in order to make the smartest decisions about when to use them.
What Are Debit Cards?
Debit cards allow users to access funds directly from their bank account when making a purchase. This means that whatever amount is spent is taken out of the existing money already sitting in your checking account. As such, it’s important to know how much money is available in the account as any purchase made that exceeds the account balance will be denied or charged with overdraft fees.
Types of Debit Cards
Besides the different debit card tiers/classes banks offer, there are two main types of debit cards you need to understand:
- Standard debit cards: these allow users to draw money or pay directly from their bank account funds.
- Prepaid debit cards: users can preload money into them to store it and spend it digitally without having to deal with opening a bank account.
Benefits of Debit Cards
There are many benefits debit cards offer to their users. Some of the most important are:
- Avoiding Debt: Since the purchased amount is taken directly from their bank account, the user will be protected from falling into high-interest debt.
- Keeping financials on point: if used responsibly, and if regularly monitored, debit cards can also help users stay within their budget by limiting how much money can be spent at any given time. This helps ensure responsible spending habits which are beneficial for financial health overall.
- Better for withdrawals: using debit cards to withdraw money from an ATM is the best way to avoid unnecessary fees and interest rates. When withdrawing with a credit card, known as “cashback advance”, banks can charge up to a 5% interest rate. If users want to avoid any fees, using debit cards at ATMs specific to their checking account is the best option.
Drawbacks of Debit Cards
Like all things, there are also downsides to using credit cards.
- Doesn’t build up a credit score: payments done with debit cards do not count in the credit history of the user, meaning it won’t positively affect their credit scores. Low credit hinders getting approved for high lending limits, can cause higher interest rates on loans, can make getting a car difficult and expensive, and can affect your ability to purchase a home.
- No rewards: users lose out on potential cashback or travel rewards they would otherwise receive through points-based systems. While these reward programs may not appeal to everyone’s tastes, they can provide substantial savings for people who use them regularly (and smartly).
- Potential for fraud: While debit card fraud protection has had many recent advances, the user is still more unprotected from fraud using a debit card than a credit card. Debit cards only limit fraud liability to $50 if the user reports their card is lost or stolen within two business days. If the report comes after that, but before 60 days, the liability scales to $500.
What Are Credit Cards?
Put simply, credit cards allow the user to make purchases now and pay them later. The general rule is that users have a grace period to repay the balance incurred or interest will be charged over it. The two main forms of repayment are 1. reimbursing the expense in full in one month or 2. paying over time with a number of installments.
Types of Credit Cards
There are 6 main types of credit cards:
- Rewards credit cards: gives users points or cashback with their purchases. They may offer bonus points on certain spending categories like food, shopping, or travel purchases.
- Travel credit cards: offer rewards geared towards traveling, such as miles or VIP access to airport lounges. Here is a list of the best travel credit cards you can access right now.
- Business credit cards: allow business owners to have personal and business expenses separate, while still gaining rewards from their business purchases.
- Student credit cards: starter credit cards directed to students, as they have low requirements, low fees, and don’t need an extensive credit history to be owned.
- Secured credit cards: they require the user to put collateral funds to secure a line of credit, usually for a similar amount.
- Store/Branded credit cards: they are used within the specific store that offers them and works by awarding regular customers with gifts, points, and discounts for future purchases.
Benefits of Credit Cards
The 3 main benefits of credit cards are:
- They build up your credit score: every credit card payment a user makes on time increases their credit score. Having a good credit score gives users more negotiating power and higher lending limits with banks, as they are seen as responsible citizens that will most likely pay on time.
- Rewards, yay!: all kinds of credit cards give rewards for using them when purchasing goods or services, saving users a lot of money in the long run. From restaurants to hotel stays, rewards credit cards can offset costs so that you can eat well or travel well without breaking the bank.
- Higher spending limits: a credit card allows users to purchase things above their means and allows users to spread out payments through lower monthly installments.
Drawbacks of Credit Cards
While they have some benefits, they also do drawbacks:
- Hidden costs: A variety of taxes and fees are associated with credit cards, including processing, joining, renewal, and late payment penalties.
- High-interest rates: not paying your balance on time will result in high-interest rates applied on the amount owed. Late payments also might result in the user's credit limit being reduced, which would lower their credit score.
- Easy to overuse: It can be tempting for the user to charge all purchases on their credit card since their bank balance remains (seemingly) unchanged. This can cause them to spend more than they can afford to pay back, starting a cycle of debt with high-interest rates on future payments.
If you are trapped in a debt cycle with your student loans, check out our list of the Best Loan Forgiveness Plans available.
Opening a debit card vs a credit card is ultimately based on your personal goals. Whether you are trying to create better spending habits by limiting your spending with a debit card, or collect travel rewards using a credit card, there’s no such thing as one being better than the other. They operate differently and offer their unique set of pros and cons. Ultimately, you’ll know what’s best for you.