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Credit vs. debit: How to choose the right payment option

Not all plastic is created equal.

Author Justin Cupler
Contributing Writer at Tally
Updated: October 2, 2020

From membership cards and discount cards to loyalty cards and beyond, the amount of plastic in our wallets has hit new heights. But there are two staples that can cause some confusion: debit cards and credit cards.

When it comes to credit vs. debit, is one better than the other? And how do you know when to use each one? Before we answer those questions, let’s compare the primary features between credit cards and debit cards.

What is a credit card?

A credit card is a card that’s tied to a pre-approved account with a spending cap known as a credit limit. When you swipe your credit card to make a purchase, the money isn’t withdrawn from your bank account. Instead, it pulls from your credit account and reduces your available balance, which is your credit limit minus any charges.

Credit cards work as a short-term revolving loan, meaning you can use it over and over again as long as you have an available balance. Some features that set a credit card apart from a debit card are as follows.

Fees and other charges

Fees are one of the most significant downsides to credit cards. While fees vary by credit card company, they generally include a late fee (if you pay your bill after the due date) and, in some cases, an annual fee just for having the card. The average credit card late fee runs $36 and the average annual fee will set you back $110.

Most credit cards also come with an interest rate or annual percentage rate (APR), which is the percentage you pay to the credit card company for their short-term loan. The average interest rate on a credit card is 20.71%, so interest charges can add up if you make substantial charges on your card.

Credit card companies calculate your annual interest based on your statement balance then spread it out over 12 months. The credit card company then applies one month’s worth of interest on each monthly statement.

For example, if you have a card with a $1,000 balance at 20.71% APR, the yearly interest would be $201.10. Divided by 12 months, that would be $17.26. When you receive your monthly statement, you would see $17.26 in interest applied to that month.

Monthly payments

Instead of making you pay for charges immediately, the credit card company will send you a monthly statement showing your credit limit, available balance, all charges, the total amount you owe and the minimum monthly payment required.

With most credit cards, you can choose to pay the minimum monthly amount, pay off the entire balance or pay a custom amount. One exception to this payment system is a charge card, which requires you to pay the balance in full each month.

The monthly minimum payment varies by credit card issuer. Generally, the minimum payment is interest accrued that month plus a certain percentage of the balance. A standard minimum payment calculation is 1% of the balance plus the monthly interest.

Using the $1,000 balance example mentioned earlier, your minimum payment would be $27.26. While this low monthly payment on a $1,000 balance may sound like a great deal, you’re paying $17.26 in interest and only $10 toward the $1,000 balance. At this rate, it would take you nearly five years to pay off that $1,000, and cost you almost $600 in interest charges.

Credit card rewards

The world of credit cards is competitive, and credit card companies are always looking for a leg up on the competition. One way they attract new customers is by offering credit card rewards.

Credit card rewards are small perks you get just for using the credit card. Perks can include cash back, gift cards, discounts on travel and more. When used responsibly, these credit card rewards can add up to huge savings.

What is a debit card?

Credit vs. debit: Customer paying with debit card

A debit card may look and feel just like a credit card — typically, there’s even a Visa or Mastercard logo — but it’s altogether different. Some debit card features that differ from a credit card are as follows.

It’s connected to your checking account

Each time you use a debit card, it deducts the purchase amount directly from your checking account.

For example, if you have $1,000 in your checking account and use your debit card to make a $100 purchase, your balance would be $900.

Depending on your bank and the merchant, it may take a day or so for your debits to show on your account. This delay is why it’s essential to maintain proper bookkeeping by writing all your debits and credits into your checking account register or a notebook. If you rely only on your online banking balance, you may end up overcharging your account and risk an embarrassing rejection at the cash register.

Because a debit card deducts directly from your checking account, you will never receive a bill or statement for your debit card. The closest thing to a debit card statement you’ll receive is a checking account statement showing all your debits and credits.

Fees and other charges

Unlike a credit card, banks generally don’t charge a fee for having a debit card. Instead, many banks will roll any costs associated with issuing a debit card into the checking account’s monthly maintenance fee. That said, as the banking industry becomes more competitive, many banks now waive these fees if you maintain a certain account balance. Some have dropped maintenance fees altogether.

Before July 1, 2010, debit cardholders had to be concerned with overdraft fees. If you attempted to process a debit card purchase but lacked sufficient funds in your checking account, many banks would approve the transaction but charge you a costly overdraft fee.

However, the Federal Reserve passed a law prohibiting banks from charging overdraft fees, unless the customer opted in to the bank’s overdraft protection service. If a customer didn’t opt-in to the overdraft protection, the bank had to reject any overdrafts automatically and could not charge a fee.

Interest

Unlike a credit card, a debit card doesn’t have interest charges. On the contrary, the checking account it’s connected to may have an interest rate it pays to you, the account holder, for your average monthly balance.

Commonly called the annual percentage yield, this interest rate is quite low in most cases – 0.10% to 0.50% – but any small amount of extra cash helps. So, the less you swipe that debit card, the more interest your account can earn.

What are the pros and cons of a credit card?

Credit vs. debit: Man looking at his smartphone

Credit cards often get a bad rap, but it’s not all gloom and doom in the world of credit.

Credit card pros

  • On-demand access to funds
  • Reward points can lead to big savings
  • Available 0% promotional financing
  • Some feature valuable consumer protections, like rental car insurance and fraud protection

Credit card cons

What are the pros and cons of a debit card?

Debit cards can help you from getting in debt, but they are far from perfect.

Debit card pros

  • You can’t spend more money than you have, so you eliminate the risk of overspending
  • No interest on purchases
  • Easy access to liquid cash at an ATM
  • Accepted wherever credit cards are accepted

Debit card cons

  • Not much help when an emergency strikes
  • Rarely offer reward points and other perks
  • Fraudulent charges on your debit card can have an immediate impact on your finances as your bank rectifies the issue

Credit vs. debit

When it’s time to pay, you may struggle to decide which is the better option. Fortunately, there are some clear-cut guidelines to choosing between a debit card and a credit card.

When should you use a debit card?

A debit card is the best option in most circumstances, as it taps into the cash you have on hand and won’t accrue interest or rack up debt. For instance, there may be a great sale on a 65-inch TV you want, but putting it on a credit card and paying the interest charges can negate any savings from the sale.

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When should you use a credit card?

While credit cards aren’t ideal, there are times when they’re particularly handy. There are also situations when it makes more sense to use them instead of a debit card. Here are a few examples.

You can get 0% APR

Like credit card rewards, some credit card companies attract new customers through promotional APR offers. These offers are typically 0% APR for a year or longer and allow you to pay for a large purchase over time with no penalty.

If you plan to make a large purchase in the next few months and can get your hands on a 0% APR credit card, you can make that purchase now and pay it off over time without interest. It’s a win-win.

Taking advantage of a promotional APR is only for the most disciplined people, though. You must budget your monthly payments in a way that pays off the account before the introductory APR expires.

You’re racking up rewards points

Rewards points can lead to valuable savings over time, so using a rewards credit card makes sense in some cases. If you limit your credit card purchases to only what you plan to spend every month anyways, you can use your rewards credit card and rake in the points.

For example, say your budget includes $1,250 in expenses. If you charge that to a credit card that earns 1.5% cash back, you can pocket $18.75 per month in rewards just for spending money you already planned to spend.

The caveat is you must pay off the total balance when you receive your monthly statement. If not, the credit card company will charge you interest.

You’re renting a car

Smiling couple in a rental car

When you rent a vehicle, the rental company often offers you some type of insurance at the rental counter. Auto insurance companies say this is unnecessary if you already have car insurance and a credit card.

It’s not necessary because first, your auto insurance will cover the rental car with the same coverages you already have. Second, most major credit cards come with some type of rental car insurance. So, if you pay for the rental car with a credit card, that card’s policy will cover the vehicle.

Credit car insurance policies vary on rental cars, so call or check the terms to see if it offers primary or secondary insurance. If it’s primary coverage, the card covers your vehicle just like any auto insurance policy. If it’s secondary, the card may cover expenses not handled by your auto insurance, including deductibles, loss of use for the rental company and other uncovered damages.

It’s a legitimate emergency

Sound personal finances include an emergency fund to cover unexpected events, like loss of income, home and auto repairs, medical expenses and more. But not everyone has the means to set aside the recommended 3-6 months of expenses. When liquid cash isn’t available, a credit card can help.

But before you reach for the credit card, explore all other options, including borrowing from a friend or family member, checking local charities and religious organizations, applying for a personal loan or line of credit and other financing options.

If you’ve exhausted all your resources and still can’t come up with the cash to cover an emergency, this is the time when a credit card comes in handy. Don’t use just any credit card, though. If possible, use a credit card with some benefits like reward points or 0% APR.

Credit vs. debit: A decision made simple

Credit vs. debit: Woman looking at a fork in the road

With a firm understanding of credit vs. debit, you no longer need to have that internal debate about which payment method to choose. In most cases, your debit card will be the best bet as you can avoid accruing interest fees and racking up credit card debt. But there are times when a credit card may make more sense and even save you money.

Save money, manage your cards and pay down debt faster!

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