Debit Card vs. Credit Card: An Overview
Many debit cards and credit cards have similar features. Typically, both cards carry the logo of a major credit card company, such as Visa or MasterCard, and both can be swiped at retailers to purchase goods and services.
However, the key difference between the two cards is where the money is drawn from when a purchase is made. When a consumer uses a debit card, the money comes directly from his or her checking account. When he or she uses a credit card, the purchase is charged to a line of credit for which he or she is billed at a later date.
A debit card may come with an overdraft line of credit connected to a customer’s checking account to cover overspending. A credit card has a specified amount of credit connected to it, and if a consumer tries to spend beyond the credit limit, the card will be denied.
KEY TAKEAWAYS
Credit cards are debt instruments, debit cards are not.
Unless a checking account comes with an overdraft, debit card users can only spend what the money available in his or her account.
A standard debit card is linked to a checking account, a prepaid debit card is not.
A credit card is linked to a line of credit offered by the company that issued the card.
Debit Card
A debit card might look like a credit card but it is distinctly different than one. A debit card is issued by a bank to their customers for the purpose of accessing funds without having to write a paper check or make a cash withdrawal.
A debit card is linked to one’s checking account and can be used anywhere credit cards are permitted. If your debit card has a Visa logo, for example, it can be used anywhere that takes Visa.
When you use a debit card, the bank places a hold in the amount you have spent. Depending on the purchase amount and your bank, the money will either go immediately out of your account or be held by the bank for 24 hours or longer.
You can use your debit card to withdraw cash from your checking account by using a unique personal identification number (PIN). When you use your debit card for a purchase, you may be asked for your PIN or you may simply be asked to sign for the purchase, similar to a credit card.
For people who are trying to budget or not over-extend themselves financially, a debit card linked to a checking account may be a better option than a credit card. Some debit cards are prepaid, and funds are loaded onto the card by a financial institution. These cards can be used in the same manner as a standard-issued debt bank card. However, prepaid cards are just that, prepaid, and they are not linked to a person’s checking account.
Credit Card
A credit card is a debt instrument to be used for financial transactions in lieu of cash or check, or a debit card. Depending on its owner’s credit-worthiness, a credit card may have come with a high spending limit or a lower one. When you use a credit card, the purchase amount is automatically added to your outstanding balance.
With most credit card companies, a customer has 30 days to pay before interest is charged on the outstanding balance, though in some cases, interest starts accruing right away.
Interest rates on credit cards can be notoriously high; they are a chief way credit card companies make money. Savvy consumers can avoid paying it by settling their balance in full each month.
Responsible credit card users can often earn points and rewards from card issuers, and using credit in a positive manner helps build and maintain a strong credit score.
Debit Card vs. Credit Card: An Example
Consider two customers who each purchase a television from a local electronics store at a price of $300. One uses a standard debit card, and the other uses a credit card. The debit card customer swipes his card, and his bank immediately places a $300 hold on his account, effectively earmarking that money for the television purchase and preventing him from spending it on something else. Over the next one to three days, the store sends the transaction details to the bank, which electronically transfers the funds to the store.
The other customer uses a traditional credit card. When he swipes it, the credit card company automatically adds the purchase price to his card account’s outstanding balance. He has until his next billing due date to reimburse the company, by paying some or all of the amount shown on his statement.
Special Considerations
By definition, all credit cards are debt instruments. Whenever someone uses a credit card for a transaction, the cardholder is essentially just borrowing money from a company, because the credit card user is still obligated to repay the credit card company.
Debit cards, on the other hand, are not debt instruments because whenever someone uses a debit card to make a payment, that person is really just tapping into his or her bank account. With the exception of any related transaction costs, the debit user does not owe money to any external party; the purchase was made his or her own available funds.
However, the distinction between debt and non-debt instruments becomes blurred if a debit card user decides to implement overdraft protection. In this case, whenever a person withdraws more money than is available in his or her account, the bank pays the outstanding amount. The bank account-holder is then obligated to repay the account balance owed and any interest charges that apply to using the overdraft protection.
Overdraft protection is designed to prevent embarrassing situations, such as bounced checks or declined debit transactions. However, this protection does not come cheaply; the interest rates charged by banks for using overdraft protection are as high, if not higher, than the ones associated with credit cards. Therefore, using a debit card with overdraft protection can result in debt-like consequences.
