Debit card usage, in dollars, has doubled since 2005, according to PaymentsSource.com. It seems that everyone is using a debit card, and telling you that it’s better than using credit. After all, who wants to go into debt with a credit card when you can use your money and pay right now? Sounds like a good argument, and the social proof is certainly visible, but just because everyone is using a debit card doesn’t mean it’s better – or good for you.
What is a debit card anyway? The Washington State Department of Financial Institutions offers a clear definition to consumers:
“A debit card looks like a credit card, but works like an electronic check because the payment is deducted directly from a checking or savings account. Most debit cards also can be used to withdraw cash at ATMs (automated teller machines).”
And therein lies the fundamental difference between the two:
- A credit card is just that, a credit card, and the laws that govern its usage fall under the Fair Credit and Billing Act (FCBA).
- The debit card looks like a credit card, but it actually is an electronic check, and its usage is covered under the Electronic Funds Transfer Act (EFTA).
Are debit cards good for your financial health? Let’s take a look at the pros and cons:
- No debt. When you use your debit card, it’s just like using cash. You can only spend what you have.
- Easier to budget. Your account balance is the maximum you can spend. You can allocate your spending based on your income and expenses, without worrying about going over the limit.
- Convenience. If you’re young or have bad credit, a debit card allows you to use plastic to make purchases instead of having to carry cash. For those under 21, debit cards are also easier to qualify for than a credit card.
- Learning tool. A prepaid debit card helps younger children gain experience with managing electronic transactions.
- Free of charges. You can use it as an ATM card to get cash from your account—sometimes without paying a fee. Getting cash using a credit card triggers a cash advance charge.
- Holds onto your money. Gas and hotel merchants will put large holds on your accounts when you use a debit card. Also, you may not have access to that money for a limited time, and – during that time – your outstanding checks can bounce, if there aren’t enough funds in your account.
- Potential unlimited liability. Laws protecting debit cards are not as strong as credit cards, which are limited to $50 under the FCBA. But debit cards are covered by the EFTA, which can leave you holding the bag for $500 or more for fraudulent charges that hit your account.
- Handling fraud. You have to get your money back if it’s stolen from your debit card account. If your credit card is stolen and used, all you have to do is contact the credit card bank, and they investigate. You don’t lose any of your money.
- Credit history and credit score. A debit card does not build your credit history or improve your credit score, because usage isn’t reported to the credit bureaus. If you buy something for $100 using your debit card, it’s like you paid cash; if you use a credit card and pay it off in full when the bill arrives, that activity is reported positively and improves your credit score.
- Fewer perks. There are some rewards with debit cards, but they’re not nearly as generous. But I’ve received thousands of dollars in cash benefits over the years from using my credit cards for everything I need to purchase: rewards, extended warranties, air travel insurance, and loss protection are just some of the many benefits.
- Overdraw potential. Checks can bounce, if you don’t stay on top of your balances. Say you have $1,000 in the bank. You write a check for $500, but in the meantime spend $600, leaving a $400 balance. Then that $500 check you forgot about shows up and bounces – sticking you with a $35 fee.
- Less leverage with merchants. You can do a chargeback if you have a problem with a merchant, and used a credit card. Not so with debit cards, because it’s like you paid cash.
Personally, I would never use a debit card except as an ATM card. The cons are just too great. Plus, I’ve heard from many people who had every problem on the con list.
I’ve had a few unauthorized charges with credit cards, but, in every case, the credit card issuer investigated and found that I wasn’t responsible for the charges. With a credit card, the issuer or merchant had to deal with the problem – not me. That’s the position you want to be in, too: Making sure your personal money is safe and sound, while issuers take the risk for the profits they receive.
Should you use a debit card? I think the choice is clear, but I’d like to hear your feedback.
Scott Bilker is the founder of DebtSmart.com and author of the best-selling books, Talk Your Way Out of Credit Card Debt, Credit Card and Debt Management, and How to be more Credit Card and Debt Smart.