Credit or debit: What’s the difference?

Credit cards and debit cards are two mainstays of consumer spending—in 2014, 78 percent of Americans preferred these two payment methods [] over any other, including cash. But what are the differences between the two? The source of money. When consumers pay for

Credit cards and debit cards are two mainstays of consumer spending—in 2014, 78 percent of Americans preferred these two payment methods over any other, including cash. But what are the differences between the two?

The source of money. When consumers pay for a purchase with a debit card, the payment gets immediately withdrawn from the checking account and transferred into the merchant’s account. In other words, the debit card lets consumers access money they have on hand. A credit card transaction, on the other hand, draws on a line of credit, creating a mini-loan from the bank. The merchant gets paid by the bank, and the cardholder is responsible for paying the bank back later. Every month, at least part of the balance has to be paid using funds from another account, like a checking account. As a result, the two accounts are shown separately in a bank ledger, allowing funds to be moved easily from one account to the other.

Payment for overspending. Because a debit card is linked to the money in a checking account, it won’t send someone into debt—exactly. But if a debit card transaction or cash withdrawal depletes the checking account and overdraws it, two things can happen. If overdraft protection is enabled, the bank will often allow the transaction to go through anyway (spotting the cardholder the money, essentially) and charge an overdraft fee, which is often around $35. The bank generally expects to be paid back the deficit within a few days, and most banks have a maximum of how many overdraft fees can be charged in one day. Without overdraft protection, the transaction will simply be denied, and the cardholder will be charged a nonsufficient funds fee. A credit card, on the other hand, lets someone spend up to a certain limit (which, for new cardholders, can range from about $500 to $9,500, and is set depending on one’s credit score). If the cardholder tries to spend beyond the limit in a given month, the credit card gets denied. But even the limit doesn’t keep people from spending more money than they have—and that’s what credit card companies count on to turn a profit. Each month, cardholders are asked to make a minimum payment (say, $25), but if the month’s balance is not paid in full, it carries over with interest that has to get paid eventually (and keeps growing if it’s not). U.S. consumers owe an average of $2,630 in interest a year, and credit card debt is one of the most expensive kinds of debt. The average annual percentage rate (APR) for credit cards is 18 percent, while the weighted average for credit card, mortgage, car, and student loan debt combined is only 5.3 percent. It’s no wonder, then, that 38 percent of American households have credit card debt.

Rewards. One of the biggest incentives to use credit cards is their abundant rewards programs. Many of these are structured around receiving redeemable points based on a percentage of spending, cash back based on purchases, or airline miles for flights bought with a credit card. Moreover, airlines and many major stores offer co-branded credit cards that result in even better rewards for purchases made with that retailer. 55 percent of cardholders list rewards programs as the most attractive feature of their credit cards. Debit cards, on the other hand, used to have similar rewards programs, but these were largely eliminated by banks after the Durbin Amendment was passed in 2010 and capped the increasingly exorbitant debit card transaction fees. Because these fees were a major source of profit for banks, banks no longer had a reason to incentivize debit card use and slashed the programs, which were costing them millions of dollars. However, in recent years, as debit cards have gained in popularity, some debit rewards programs have returned. They are slightly different now, however, and primarily offer discounts at retailers where the cardholder has previously made a purchase.

Building credit. Simply put, spending money on a credit card—and paying it off regularly—helps build a credit score, which is a crucial number that can help someone rent or buy housing, get a good insurance plan, and even get hired. Because debit cards rely on people spending their own money, they don’t build credit, and the activity on the debit card does not affect the credit score.

Fraud protection. Credit and debit cards also differ in the amount of protection they offer their consumers. Many credit card companies offer zero-liability fraud protection, meaning that if the number is lost or stolen and fraudulent transactions are made, the card issuer credits the account, and spending is unaffected. A lost or stolen debit card, however, can lead to much more of a headache. Consumers have up to 60 days to report debit card fraud, during which they are liable for up to $500. After the 60 days are up, however, there is no protection, and the cardholder is responsible for any fraudulent purchases. What it comes down to is the fact that a purchase made with a credit card is actually being made with the bank’s money; therefore, the bank has more of a vested interest in contesting those transactions. A debit card uses a cardholder’s own money, so protection is not as big of a priority.

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