Cash may be king, but debit and credit cards lead the pack as preferred payment methods. The latest findings from the Federal Reserve Bank of San Francisco show just 23% of people prefer to pay for goods and services with cash, while a combined 71% would rather use a debit or credit card. But how do they differ, and does it matter which card you use for your purchase?
The Difference Between Credit and Debit
Credit and debit cards are two separate products that use different funding sources. Debit card purchases are deducted directly from cash in your bank account, while credit card purchases are a loan that you pay back to the issuer according to the card’s agreement terms.
Debit Cards: The Pros and Cons
Some of the advantages of buying with debit cards are:
- Supports small businesses: Shop keepers typically pay less processing fees with debit purchases than with credit.
- Helps avoid falling into debt: Like paying with cash, you can only spend up to what you have in your account.
- Easier to get: Many debit cards come free when opening a checking account, and prepaid debit cards have higher approval rates since they aren’t a loan.
But, debit transactions aren’t without drawbacks:
- Can exhaust savings and other funds: Having low to no account funds could leave you strapped for cash in emergencies.
- Difficult for large purchases: Debit purchases are paid all at once, making it much harder to buy high-ticket items.
Credit Cards: The Pros and Cons
Using credit cards also comes with its share of benefits:
- Makes purchases more affordable: Purchases are spread out into monthly payments.
- Builds credit: Credit scores are important in getting a car loan, mortgage, and other types of financing.
- Has better fraud protection: You won’t pay more than $50 out of pocket for credit card fraud, but your liability could be unlimited with debit cards.
- The cash in your bank account isn’t exposed in the event of fraud or theft.
- Credit cards typically have purchase protection, warranty extensions, and other benefits above and beyond what you get with debit cards.
- More available funds: Your revolving credit limit is often higher than what you would have in a bank account.
That said, here’s where credit cards fall short:
- Encourages overspending: High credit limits make it too easy to overspend and get into debt.
- Creates a debt cycle: High-interest rates mean most of your minimum payment goes toward the interest instead of your principal balance.
- Stores with minimum purchase: Some stores won’t let you use a credit card for purchases under a specific dollar amount.
- Can hurt your credit: Making late payments or using too much of your credit line can hurt instead of help your credit score.
Which One Should You Use?
Whether a debit or credit card is the best choice for your transaction depends on your circumstance. Here’s when one card trumps the other.
Debit cards may be the smartest move if you want to:
- Limit your spending and avoid getting into debt.
- Keep easier control of your budget.
- Make sure you won’t pay interest rates.
- Get the best foreign exchange rates by withdrawing local currency from an ATM. Your exchange rate is better than if you swipe your debit card.
However, credit cards may be best if you:
- Are making an online purchase or traveling abroad. Credit cards have better fraud protection.
- Want to earn rewards for your spending to redeem for gift cards, cashback, traveling and more.
- Plan on making a large or electronic purchase. Many credit cards have their own warranty protection that goes beyond that of the manufacturer’s.
- Don’t want to worry about getting charged overdraft draft fees due to insufficient funds.
5 Tips for Helping Avoid Excessive Credit Card Debt
These five tips will help ensure that credit cards are useful tools instead of debt traps.
- Try to pay card balances off every month so that debt doesn’t accrue.
- Pay more than the minimum payment to spend less overall in interest.
- Avoid high-interest credit cards because they can be more challenging to pay off.
- Match your credit card spending with your budget to avoid buying more than you can afford.
- Limit your number of credit cards to keep balances in check.
Both debit and credit cards can be friend or foe, depending on how you use them. Knowing which one serves you best for your purchase helps maximize the benefits of each and keeps you moving toward your financial goals.
Click here to read more blog posts.