Debit and credit cards can look the same, but they’re very different in how they work. Knowing how to use a debit card wisely can save you many headaches if you’re used to using that other common piece of plastic in your wallet or purse: a credit card.
Here’s a breakdown of how debit cards work:
Yes, Debit Cards Are Connected to Funds in Your Bank Account
A debit card is connected to a bank account and works like an electronic check. Once a debit card is run by a cashier through a scanner, for example, the payment is deducted directly from a checking or savings account. The bank will electronically verify that the money is available and will approve the transaction.
Debit Card Pros: Fast & Easy to Use, No Interest, Safer Than Cash
A debit card can be easier and faster to use than writing a paper check and safer than carrying around cash, even though you can use a debit card to get cash from your bank account when it’s used to make a store purchase. Also, interest isn’t charged for using a debit card.
Debit Card Cons: Can Lead to Overdraft Fees
You must remember that an approved transaction could still lead to the account being overdrawn if there isn’t enough money in it, just as a bounced check can lead to a fee.
A debit card purchase is posted within 24 hours, but the bank may not know what other withdrawals a debit card holder made that day until it settles all transactions later on in the same day. Even if you only have $100 in your bank account and you use a debit card for a $200 purchase, the bank may still approve the $200 purchase and assess an overdraft fee for that transaction and subsequent ones until a deposit is made to cover the withdrawals.
Using a debit card can be a smart decision for consumers who want to stay out of debt by only buying what they can immediately afford, but there are some instances when the benefits of a credit card are worthwhile.
Debit Cards Vs. Credit Cards
The other most commonly-used form of plastic is credit cards, which allow users to borrow money at the point of sale and pay the balance up to a month later without interest.
Credit Card Pros: Can Improve Credit Score, Funds Available Immediately
Credit cards are accepted by almost all businesses around the world, and using them wisely (i.e., paying them off in full each month before interest charges take effect) can help make purchases easier and improve your credit score. Thirty-five percent of your FICO credit score is determined by payment history, so making payments on time can have a huge impact.
Pros for Poor Credit: You Can Still Apply & Work to Rebuild Your Credit
A credit card can be especially handy to cover certain expenses when funds are tight, and you don’t necessarily need good credit to get approved for one. Best of all, they can help you rebuild your credit when used responsibly.
Below are our top expert-reviewed credit cards for consumers with low credit scores:
Credit Card Cons: Can Lead to Debt
But if you can’t control your spending, a credit card may not be your safest option.
It’s not a secret that credit cards lead some people into debt. If you spend excessively and are unable to pay your balance in full each month, that remaining balance will continue to accrue interest until it is paid. That’s how credit card companies make money — your interest payments.
If you’re worried about overspending with a credit card or not having enough money in your bank account to pay a debit card transaction, then another option is a prepaid card.
Debit Cards Vs. Prepaid Cards
A prepaid card works like a debit card, though money isn’t withdrawn from a connected bank account. Instead, prepaid cardholders load money onto a card through direct deposit or with cash, among other methods, and can spend up to the loaded amount on the prepaid card.
Prepaid Card Pros: No Interest, Safer Than Cash, No Bank Account Required
Prepaid cards are safer than carrying cash and don’t require a credit check or bank account to apply. They’re typically accepted any place that takes credit or debit cards. Prepaid cards don’t have a credit line or interest rate, as credit cards do, and they aren’t tied to bank accounts, as debit cards are.
Prepaid Card Cons: Will Not Help Credit
For people who don’t have access to or don’t want to use credit cards or banks, prepaid cards can be a good solution. They don’t, however, help build credit. Without good credit, consumers could end up with higher interest rates on loans they take out in the future.
The best solution for people starting to build their financial lives may be to have all three cards: debit, prepaid and credit. From there, they can develop good credit behavior by paying credit bills on time and in full each month, not spending more money than they have in the bank, and following a monthly budget.
Photo Credits: Consumerreports.org