Debit and credit cards are used worldwide and they look alike, but they have major differences. A debit card takes funds directly from your bank account, while a credit card is linked to a credit line that you can pay back later. It's important to understand these differences for financial management and decision-making. Discover their interest implications and their impact on your credit history and when one might be better than the other.
KEY TAKEAWAYS
- Debit cards draw money directly from your bank account, while credit cards let you borrow funds you'll repay later.
- Credit cards can improve your credit score, while debit cards have no impact on it.
- Debit cards don't charge interest, but may incur overdraft fees if you spend more than your balance.
- Credit cards offer greater consumer protections and often provide rewards like cash back or airline miles.
- Debit and credit cards are essential tools for managing finances and navigating today's cashless society.
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Investopedia / Sabrina Jiang
Understanding How Debit Cards Function
Banks issue debit cards to their customers so they can make purchases or obtain cash without having to write a paper check or visit a teller at the bank. The card is linked to your checking account or sometimes a savings account.
How to Use a Debit Card
Use debit cards to withdraw cash at automatic teller machines ATMs and make purchases in-store or online. When the card is used in a transaction, the money comes out of the linked account either immediately or after a brief interval. If you don't have enough money in the account to cover the transaction, your card may be rejected.
PIN and Validation Codes
Debit cards have a unique personal identification number (PIN) that you enter at ATMs or point-of-sale terminals. However, with online transactions, you may be asked for the card's validation code located on the back of the card as a security measure.
Debit Card Network
Most debit cards are linked to a network like Visa or Mastercard and can be used wherever accepted. Although most debit cards link to your bank account, offline debit cards are not electronically connected to your account.
Understanding How Credit Cards Function
Credit cards are also issued by banks but require a separate application process. You don't need to open or maintain a bank account with the company to apply.
How to Use a Credit Card
Credit cards aren't linked to a bank account, but they provide a credit line up to a preset limit. Like debit cards, credit cards can be used at ATMs, but cash advances can be costly due to fees and interest.
How Credit Cards Charge Interest
Card issuers charge interest on the money the cardholder borrows, although cardholders can often avoid interest if they pay back their full balance within their card's grace period.
Credit Card Network
Like debit cards, credit cards typically belong to a card network like Visa and Mastercard and can be used anywhere cards in that network are accepted. Private label or store credit cards are an exception since they are only valid at a particular retail chain.
Comparing the Key Differences Between Debit and Credit Cards
Beyond the differences mentioned, debit and credit cards have other distinctions. Among the most important ones:
- Debit cards won't affect your credit score. Your credit score is a three-digit number reflecting your creditworthiness. Your credit score is based on information supplied to credit bureaus by your various creditors, including any credit card issuers. Consistently paying your credit card bills on time will help your credit score, while missing or late payments will hurt your score. However, debit cards don't report to credit bureaus, so they won't affect your credit score one way or the other.
- Debit cards don't charge interest. You won't owe interest on your debit card because you aren't borrowing money. With overdraft protection, if you overspend, the bank covers the excess, but you'll incur fees.
- Credit cards often pay rewards. Many credit cards offer rewards like cash back or airline miles on purchases. Some debit cards and checking accounts also pay rewards but tend to be less generous.
- Credit cards have better consumer protections. Different laws govern credit and debit cards. Your liability for fraudulent charges with a credit card is typically capped at $50 and sometimes $0. With a debit card, you could (in the worst-case scenario) lose all of the money in your linked accounts.1
Evaluating Credit Cards vs. Debit Cards: Which Is Superior?
Both credit and debit cards can be handy when managing your personal finances, and can be nearly impossible to avoid using them in today's financial world. Some merchants don't accept cash or checks anymore.
Credit cards can be especially useful if you need to make a purchase or face a financial emergency and don't have enough cash available in your checking account. However, credit cards can get you into financial trouble if you don't pay down the balance and interest accrues and compounds, increasing your debt.
Conversely, debit cards can help you stay within your budget and avoid spending money you don't have in your account. Since debit cards don't involve borrowing money, you don't get charged interest. However, it's important to manage your money in your checking account because if you overspend with a debit card, you may not have the funds needed for critical expenses like rent or food.
If you're trying to build or repair your credit history, a credit card used responsibly can help. In fact, some credit cards offer credit builder features, such as student credit cards, starter credit cards, and secured credit cards.
IMPORTANT
It's important to monitor your credit reports for suspicious activity and report any suspected fraud to the three major credit bureaus. Also, you can set up a free fraud alert with one of the credit bureaus to monitor unauthorized financial activity.2
What Is an ATM Card?
An ATM card is a form of debit card that can only be used at automatic teller machines and not for purchases in stores or elsewhere.
What Is a Prepaid Debit Card?
A prepaid debit card is loaded with a specific amount of money but not linked to a bank account. Prepaid debit cards can often be reloaded with more money and used repeatedly. Gift cards also work like prepaid debit cards, although they may only be accepted by a particular retailer or chain and often aren't reloadable.
How Long Is the Grace Period on a Credit Card?
The grace periods on credit cards are usually at least 21 days long and sometimes longer.3
The Bottom Line
Debit and credit cards allow you to make purchases and withdraw cash. However, debit cards are linked to your bank account, limiting the size of your financial transactions by the amount of funds in your bank account. Conversely, credit cards are not linked to your bank account. They offer a credit line for purchases and cash advances. In return, credit card companies charge you interest on the borrowed money, but they can help you build a credit history.
There are consumer protection differences as well. Credit cards generally offer better protection against fraud than debit cards.
Select a card based on your financial goals and needs, whether to manage your budget, build your credit, or gain rewards.
