Debit or credit?
At a distance, there’s virtually no way to distinguish the small plastic cards with Visa or MasterCard logos. Both allow you to pay for goods and services instantaneously by transferring cash behind the scenes.
But anybody who understands how these two payment cards work knows the similarities are only skin-deep.
- Credit cards assign you a credit limit, an amount that you can spend on the card at any time. By definition, this is credit…not cash you actually have. When you pay with a credit card, the bank pays the merchant immediately, but you don’t have to pay the bank until the end of the month or over the course of many months (in which case the card charges you interest).
- Debit cards work like instant checks. When you pay with a debit card, the payment network immediately deducts the purchase amount from your bank account. If you don’t have the money for the purchase in the bank, you can’t spend it using a debit card. (Unless you have overdraft “protection”, in which case the bank will let the transaction go through but charge you a fee for overdrawing the account).
The great debate
Debate continues about whether debit cards or credit cards are the better way to pay. Although both debit and credit cards are, typically, more convenient than cash or checks, there are pros and cons to both.
Credit cards, for example, allow you to pay for things without worrying about cash in your bank account. This, of course, is also bad, because it can quickly lead to overspending and long-term credit card debt. Many credit cards feature rewards programs for no annual fee and many offer other benefits like purchase protection and travel insurance.
Debit cards come with some of the same benefits as credit cards (like protection if the card is lost or stolen). Unlike a credit card, however, you can’t rack up thousands in purchases that you can’t afford with a debit card. There are some situations in which debit cards may be less convenient than credit cards. For example, if a merchant like a hotel or car rental agencies requires a deposit, they’ll take actual cash out of your bank account rather than reserving a portion of your credit line.
Another complaint about debit cards has been the lack of rewards. If a credit card will give you $50 for every $5,000 you spend but a debit card won’t, why wouldn’t you use a credit card, assuming you paid it in full every month?
Finally, another thing a credit card does that a debit card cannot is help establish a credit history. Using a credit card can set you up for getting the credit score you need to get the best rates on a mortgage down the road.
Credit, debit, and the psychology of spending
Say what you will about the technical differences between credit and debit, the big distinction is how they work—and what that means for the psychology of spending.
There’s a common belief out there that we spend more with a credit card than with a debit card or cash because we’re spending “imaginary money” (in other words, not cash). Vice versa, when we spend with cash or a debit card, we “feel” the money leaving our pocket or bank account, and spending is more painful. It’s easy to believe that this is true. It makes sense. Unfortunately, other bloggers and I have not been able to find a scientific study that proves this. So it’s certainly plausible that you could spend more with a credit card, but we can’t say for sure.
What matters is how you feel about your spending. That’s right; you get to make a decision for yourself! No financial guru or blogger can tell you whether debit cards or credit cards are best for you. If you’ve dug yourself into a big red hole of credit card debt before and know that if given the plastic, you might know that you need to stick to debit. Or maybe you just don’t like the idea of credit cards so you stick to debit. I’m a firm believer that on this one, there really is not a “right” answer.
So let’s hear it!
How do you use credit and debit cards differently? Do you avoid credit cards altogether? Use both? Why?