Credit Cards or Debit Cards: Which One Is Better?

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After failing to bring his wallet to a business dinner in New York, Diners Club Card founder Frank McNamara and his partner Ralph Schneider developed and introduced the concept of a credit card in 1950. A little more than a decade later, the Bank of Delaware piloted the first debit card project in 1966.

By 2018, noncash payments in the U. S. – debit card, credit card, ACH and check payments – amounted to $174.2 billion. Of that amount, 7.3 percent were credit and debit card payments. What's more, customers used debit cards almost twice as often as credit cards. Even so, the dollar value of those credit card payments was about 30 percent greater than that of the debit card payments.

These facts are likely to give you confidence in the use of debit and credit cards. But you should also consider other factors when making the final debit versus credit card decision.

Debit vs Credit Card Function

Both debit and credit cards are issued by financial institutions. But whereas a credit card enables you to borrow funds from the card’s issuing institution to make a purchase, a debit card allows you to pay for goods and services by deducting money directly from your checking account.

As a credit card holder, you pay back the loan and the associated interest according to the terms of the credit card agreement. In contrast, as a debit card user, you incur no debt at the time of a purchase.

Cash Requirements for Cards

When you present your debit card at the time of a purchase, the amount of that purchase is deducted directly from your bank account at that time. If, however, you purchase an item using a credit card, payment is made to the vendor by the credit card issuer. Later, you pay back that amount to the card issuer within an agreed-to time period. If you delay your payment, interest is also due.

If you use a debit card, the purchase amount is limited by the cash in your bank account. When using a credit card, your purchase is limited by your credit card agreement.

Card Fee Comparison

With few exceptions, financial institutions don’t charge fees for debit cards. The card issuer can, however, charge an overdraft fee if you make a purchase that overdraws your available account balance by more than a pre-stipulated amount. Your card issuer might also charge a fee if you withdraw money from an ATM machine that’s not operated by your financial institution.

In contrast, credit card companies charge a variety of fees such as annual fees, over-limit fees and late-payment fees. The credit card company charges those fees in addition to monthly interest on your card’s outstanding balance.

Receipt of Cash Rewards

Unlike the debit card user, those who use credit cards may benefit from cash discounts, cash back on purchases as well as travel points and other rewards. To receive your rewards, you need to make your required payments on time each month or, if you prefer, pay your balance in full.

In some cases, the savings and cash you earn over time can be substantial, but you must gauge it in light of the card’s fees.

Impact on Credit Report

Purchases you make with a credit card, but not a debit card, appear on your credit reports and affect your credit score. When you use your card responsibly and make timely payments, its use can raise your score. Generally, it's a good practice to aim for a total credit utilization ratio – and ratios for each credit card – of no more than 30 percent.

The overreliance on your card for purchases and the failure to make significant and timely payments signal additional risk to the card issuer. The reason being these two red flags are an indication that, at some point, you might be unable to repay your financial obligations.

Consumer Protections for Cards

Some card issuers, such as Visa and Mastercard, offer debit card holders consumer protections that are not unlike those they offer credit card holders. For instance, card issuers may insure or provide supplemental warranties for items you purchase with your card. The consumer protections a card issuer offers are stated in the credit card agreement.

Financial Planning Impact

In the same way that casino chips and carnival tokens evade a person’s natural tendency to hold on to hard-earned cash, credit cards may increase the frequency of a card holder’s impulse purchases. In contrast, each use of a debit card immediately withdraws cash from your account. This fact may counter the urge to purchase something on a whim.

If you want to reap the benefits of using a card for purchases, rather than cash, there are a few things to consider before you choose a debit or credit card. First, think about the function, fees and cash requirements of debit and credit cards. Additionally, think about the likely effects of each type of card on your budget and credit score. Lastly, be aware that the possible rewards of one card may not outweigh the risks of using it to make your purchases.