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Credit or Debit?

Picking the Proper Plastic

By Martin H. Bosworth
ConsumerAffairs.com

July 31, 2006
Using plastic for payment is becoming so commonplace that most shoppers don't think twice about which card they're pulling out of their wallet.

Indeed, from hidden fees to security risks to rewards and benefits, credit and debit cards are becoming more and more similar.

But there are still a few crucial differences that consumers need to be aware of in order to maintain a healthy bank account and avoid becoming prey for fraudsters, hijackers, and greedy lenders looking to charge late fees, over-limit fees and other contemporary forms of usury.

Banking and Fees

Critics of credit cards generally point to debit cards as a smarter way to bank, as the transaction draws money from your account right at the point of sale (POS), whether through entering your personal identification number (PIN) or "swiping" it as you would a credit card.

The immediate withdrawal of funds should, they say, help shoppers keep a better handle on their bank balance, rather than making lots of transactions with a credit card and not keeping enough money in their account to pay the balance at the end of the month.

Debit cards can have their own pitfalls, however. The merchant you buy from may not report the transaction immediately, which may lead to overdrafts if you don't immediately mark it off your ledger yourself.

Many banks will charge overdraft fees to consumers who drain their checking accounts via constant debit-card transactions.

Merchants such as restaurants and auto rentals will often put "holds" or "security deposits" on credit and debit cards alike when users make transactions. The amount of the hold can vary widely, with some merchants putting holds of as much as $500 on any transaction made with a debit card.

The amount of money merchants can make not only depends on whether a shopper uses a debit or credit card, but on what kind of transaction they make with said card.

Using a PIN-based transaction for a debit card costs the merchant less to process, whereas an "offline" transaction with a receipt to sign is the same as using a credit card.

The high "interchange" fees banks charge retailers to process transactions are the impetus behind a major class-action lawsuit against Visa, MasterCard, and their partner banks.

Another potential drawback: Debit cards are "invisible" to the lending industry, as transactions made with debit cards are not reported by lenders to credit bureaus.

This can be both an advantage and a disadvantage for consumers. As lenders generally report only negative information (missed payments, charge-offs, delinquencies) to creditors, sticking to debit cards for your shopping needs will reduce your potential risk of having bad debt show up on your credit report.

On the other hand, lack of credit can prevent consumers from getting auto loans and mortgages, due to their "thin credit files."

Many lenders and utility companies, as well as "alternative" credit bureaus like Payment Reporting Builds Credit (PRBC) offer consumers the ability to report utility payment data in lieu of using credit.

Using debit cards at automatic teller machines (ATMs) can cost you even more money, due to the fees banks charge for using ATMs not in their network. Many banks and credit unions will reimburse consumers who make withdrawals at ATMs belonging to other banks, so be sure to ask about this option when opening a new bank account.

Security

Unfortunately, the deviousness of data thieves and lax security policies of banks and retailers has led to a mounting risk for shopping with credit and debit cards alike.

Two of the biggest breaches in online consumer security -- the CardSystems hack and the still-unsolved mass cancellation of many Visa-branded ATM and debit cards -- occurred because third-party payment processors either stored personal data without authorization, or didn't secure their networks against outside attack.

Federal law mandates that credit card users are liable for no more than $50 worth of fraudulent charges on their accounts, and both MasterCard and Visa offer "zero liability" protection for any charges made with a person's card number or offline receipt transactions.

Interestingly, they don't offer zero liability for PIN-based transactions, which are the ones that earn them the least profit.

Debit cards enjoy similar protections for the most part, but only if customers report fraudulent charges within 48 hours. If you don't report fraud or theft of their card immediately, you can end up liable for virtually all of the charges made on the card, even if it was stolen or hacked.

Banks and credit unions have individual rules governing their fraud protection plans, so read the fine print in your user agreement.

Convenience and Rewards

If racking up frequent-flyer miles and getting "cash back" is your drug of choice, credit cards are still the way to go.

Credit card clearinghouse resource site Cardratings.com offers a thorough rundown of which cards offer rewards and benefits, what the terms and conditions of each card are, and what (if any) hidden fees you may have to pay when using them.

Using your credit card to get frequent-flyer miles has become a passion rivaling collecting baseball cards, as many airlines have begun offering non-flight rewards for redeeming mileage points, such as cookware, magazine subscriptions, weekend hotel passes, and so on.

This has led to a new class of flyer called "mileage runners," who will travel long distances and rack up huge flyer mile totals, which means more profit for airlines and credit card issuers both.

Many banks and lenders have been beefing up debit cards with rewards or redeemable points in order to encourage more use.

Last year Bank of America began its "Keep The Change" program, encouraging customers to make small purchases with their cards, rounding the total up to the nearest dollar, and deducting the difference into a linked savings account.

For their part, merchants dislike linking rewards programs to "micropayments," such as using debit cards to buy food, because the cost of processing the transaction nearly wipes out the profit they make from the sale.

What's The Right Choice?

Given the dizzying range of options you can choose from when it comes to getting a credit card, and the strong push by banks and lenders towards debit cards as the "default" mode of payment for goods, what's a shopper to do?

There is no right or wrong answer. Some consumers sing the praises of credit cards for their versatility, the protections they offer, and so on. Others prefer debit cards for convenience and the need to balance their budgets, while still others eschew plastic altogether.

The ideal option is to utilize all of the above, but in ways that are appropriate to what you're shopping for. For example:

• Pay for everyday items with cash or checks. Using cash not only reduces your risk, but it costs retailers less to process, and it forces you to stay within limitations of the budget you set for yourself. Using checks allows you to "float" emergency purchases until you have the necessary funds in your account to cover them (even with the new "Check 21" processing rules), and like cash, costs retailers less to transact.

• Use debit cards for offline shopping. Debit cards work best for people who don't like carrying large wads of cash and either can't get or don't want credit cards. Make sure that your PIN is something difficult to guess and always ask any store that offers PIN-based transactions if their payment processors store your personal information.

• Use credit cards for big-ticket items and online shopping. Credit cards work best when shopping with online vendors and auctions, due to the level of protection users have against fraud or data theft. If you really want to build those reward points, credit cards will get you there. Just remember to pay your balance in full every month, and read the fine print of every cardholder agreement to avoid getting hit with mysterious "overlimit" fees or other traps.

• Always ask yourself if this is something you need plastic to purchase. As of April 2005, the United States held an astonishing $735 billion in credit card debt, of a total consumer debt of $2 trillion. The best way to avoid falling into the trap of eternal debt is to pay for things with the cash you have, when you have it.

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