You're at the checkout line and open your wallet to pay. Do you reach for your credit or debit card? Does it matter? Is one better to use than the other?
For many consumers who don't like to carry cash, a debit card is their only alternative. If they can't qualify for a credit card, using a debit card -- with a direct withdrawal from their bank account -- is the only option for paying with plastic.
According to a recent study by MasterCard, debit card users tend to have significantly lower credit scores than credit card users. If you can qualify for a credit card, chances are you have fairly good credit, and tend to pay with a credit card rather than a debit card.
While credit cards and debit cards can look the same, there's one major difference. When you pay using a debit card, the money comes straight out of your bank account. If you pay with a credit card, the purchase is applied to your credit balance.
You get a bill at the end of the billing cycle with the option to pay it in full, or pay a portion. This is where some consumers tend to get into trouble.
It adds up
For example, if a consumer makes a couple of significant purchases during the month, along with the usual meals and gasoline, he could easily add $1,200 or so to the balance. When the bill arrives, she decides paying the full balance would use too much of her bank account, so she pays only $200, planning to pay the remaining $1000 the following month.
But an unexpected car repair the following month, along with the usual smaller purchases, puts another $1,200 on the credit card. Suddenly the balance is $2200, with an interest rate of nearly 30 percent.
Not properly managed, a credit card can easily saddle consumers with high interest debt, preventing them from using their money in other ways. Consumers with a balance of $20,000 or more on credit cards are not uncommon. The $20,000 was not charged all at once, but in smaller amounts over time.
Debit cards are also not without their pitfalls, but fortunately, one of those drawbacks recently went away. Until very recently, debit card users were plagued with overdraft fees.
If they made a purchase with their debit card that overdrew their account, the purchase went through but the bank charged the consumer a "courtesy overdraft protection" fee of $35 or so. If the shopper made two or three other purchases before checking his balance, each of those purchases carried an extra $35 fee.
Rule change
Because of a change in Federal Reserve rules, banks may no longer extend that overdraft "protection" as a matter of course. Now customers must specifically tell their bank they would like that service. If they don't ask for it, purchases will be declined if they overdraw the account -- but the consumer doesn't pay an overdraft fee.
The availability of online banking makes it easier to keep track of debit card purchases and could be another reason this piece of plastic might work better for some people. If you pay as you go, you don't get any surprises at the end of the month when the credit card bill arrives and you're confronted with purchases on credit that you had forgotten you had made.
Credit cards sometimes offer "points" and rewards programs, providing a gift of some kind for heavy use of a credit card. While everyone likes getting something for "free" every once in a while, credit card companies have recently tightened restrictions on some rewards programs, in the face of a tougher regulatory environment.At the same time, some credit card issuers have begun charging an annual fee, meaning the card can cost you money, whether you use it or not.
All of which makes the lowly debit card look better and better. With the threat of overdraft fees greatly diminished, reaching for your debit card might make the most sense, even if you're giving up the chance to add more airline miles.
