Although both kinds of cards can be used to pay for goods or services, there are key differences between credit cards and debit cards. Most notably is that credit cards are borrowed funds issued by a bank, and debit cards pull funds directly from your existing bank account.
Many people have one of each in their wallets and find it's helpful to use one or the other, depending on the purchase or the situation. There are many factors to consider when choosing which card to use.
This article will cover:
- What is a debit card and how does it work
- Pros and cons of debit cards
- What is a credit card and how does it work
- Pros and cons of credit cards
- Debit vs. credit: which should you use
What is a debit card?
A debit card is linked to your checking account. It allows you to access money directly from your account for transactions, and also works as an ATM card to directly withdraw cash.
You typically can't spend any more than the amount you have in your account or your transaction will get declined. Debit cards don't charge interest or annual fees, and balance transfers are not allowed. Debit cards typically don't offer perks or rewards. However, at some banks you can earn interest on the money in your checking account.
How do debit cards work?
Your debit card places a hold on the purchase amount. The merchant sends your transaction to the bank, and your bank sends the money to the merchant's account. ATMs and many stores will require you to enter a PIN to use your card.
Pros and cons of using debit cards
Here are the pros and cons to consider when deciding whether or not to use your debit card:
- Difficult to overspend: Having a debit card makes it difficult to spend funds that you don't have.
- No interest payments: There is no balance to pay off each month, so you don't have to worry about interest accruing.
- No damage to credit history: If you're unable to pay your bills consistently on time, it might be better to access money with a debit card rather than a credit card as debit cards won't affect your credit score.
- Can be used in stores and at ATMs: You can use your debit card to make purchases as well as get cash from the ATM.
- Protection against fraudulent activity: As long as you report the charges promptly, you can get reimbursed for unauthorized debit card transactions with zero liability protection.
- You can't build credit: Debit cards won't help you build any credit history, which is important for boosting your credit score.
- You may have additional fees: Even though you won't have to pay interest, you still may have to pay ATM fees if the machine you're accessing is out of network.
- Must have funds in your account: A debit card uses funds directly from your checking account and those transactions are typically processed within 1 and 3 days, so you must have funds in your account to cover those purchases.
What is a credit card?
A credit card allows you to access a line of credit to pay for goods or services. It acts as a monthly loan you can use to make purchases then pay the credit card company back. A lender will determine the amount of credit you're approved for (your credit limit), based on factors such as your income and credit history. Unlike a debit card, credit card usage and payment history go into your credit report and affect your credit score. Credit cards allow for cash advances and balance transfers. Additionally, they often offer perks and rewards.
How do credit cards work?
When you make a transaction, the bank that is issuing your card pays the merchant. Each month you'll receive a bill listing all purchases made. You can pay the entire balance and avoid interest charges, or you can pay a portion of the balance (a minimum payment), and be charged interest (APR), on whatever amount is remaining.
If you don't pay your credit card bill at all, late fees will be applied and you could be accruing interest at a penalty rate. You also risk damage to your credit score if you neglect to pay at least the minimum payment for longer than 30 days.
Pros and cons of using credit cards
Here are the pros and cons to consider when deciding whether or not to use a credit card:
- Rewards and perks: Credit cards allow you to earn rewards, like cash back or airline miles.
- Build credit history: Credit card activity is sent to the three main credit bureaus — Experian™, Equifax® and TransUnion® — producing a credit report. This credit report shows your entire credit history and is helpful when applying for a loan, additional credit cards, rental leases and even some jobs.
- Protection against fraudulent activity: Your credit card comes with zero liability protection. So tell your issuer immediately if someone uses your card without permission and you won't be held responsible.
- Easy to rack up debt: If you're spending more than you can pay back, it can be easy to build debt over time.
- You can be charged interest: If you don't pay your balance in full each month, you'll be charged interest on the amount left unpaid. If you're not careful, this interest can quickly compound.
- Other fees: Credit cards have fees that may include balance transfer, return payment, late fees and with some cards — annual fees.
Debit card vs. credit card: Which should you use?
When determining whether to use debit or credit, be aware of how you typically manage your money. If you know you have a tendency to spend beyond your means or not watch your expenses closely, a debit card can prevent you from landing in serious debt, and may be your best option. Conversely, if you're good at sticking to a budget and carefully watching your daily purchases, a credit card is an excellent way to earn rewards and build a credit history.
Building credit history with your credit card is a valuable part of your financial journey. However, it's only helpful if you're able to pay your bills on time each month.