On the surface, credit cards and debit cards appear to be the same. Both are small, plastic cards that fit in your wallet or pocket. And both allow you to make purchases with a simple swipe, tap, or insertion.
Yet, despite their similar appearances, understanding the differences between credit and debit cards can help you take charge of your financial life and make the best decisions for you, your family, and your future.
What are credit cards?
Credit cards are linked to a line of credit from a bank, and they allow you to borrow money to make purchases. You can buy almost anything with a credit card, from airline tickets to a Sprite at your local gas station.
You can think of your line of credit as a loan from the bank that issues the card. When you make a transaction with a credit card, you are charging that amount against your line of credit, which you then pay back to the bank based on an account due date. Banks will also give you an option to pay back what you owe, known as a balance, over time. If you pay back your balance over time, you’ll be charged a monthly interest charge.
Generally speaking, however, it’s not a good idea to carry a balance, as interest rates on credit card debt is high. And by not paying off your balance, you’ll be paying more than the original price of what you purchased.
There are numerous types of credit cards, and your credit limit and interest rate is determined on a case-by-case basis, based on your credit score. Whether you rack up a balance or pay the bank back in full each month, your contract with the card issuer is binding. It’s important to keep in mind that some credit cards also charge an annual fee.
What are debit cards?
Debit cards are linked to a checking account.
Your bank or financial institution will issue you a debit card so that you are able to make purchases without having to withdraw and carry around cash. When you make a transaction, it deducts the funds directly from your account.
You can also use a debit card to withdraw cash at an ATM. Similar to making a purchase with your debit card, when you withdraw cash, the money is deducted from your checking account.
How does it all work? A merchant’s point-of-sale (POS) terminal—the machine you use to swipe or insert your card at a cash register—will verify that your bank account has the funds necessary to make the purchase, and then your bank will put a hold on the funds.
The actual transfer of funds from your bank to the merchant’s account is usually completed several days later.
How do most people use debit cards?
Typically, consumers use debit cards for day to day expenses. Using a debit card is similar to using cash, in the sense that you can make purchases using the money you already have.
Unlike cash, however, debit cards usually require a personal identification number, or PIN, to complete a transaction. A PIN number is a secret code known to the card’s owner that can add a layer of security to transactions.
However, debit cards also come with Visa or Mastercard logos, which means they can often be used without PINS. So if someone steals your card, they can potentially use the funds in your bank account.
The difference between credit cards and debit cards
How, exactly, does a debit card differ from a credit card?
The main difference between credit and debit cards has to do with where the funds are coming from. Again, a debit card is linked directly to your checking account and, therefore, uses your money to complete transactions.
Conversely, a credit card allows you to take out a small, short-term loan for purchases. The available balance or credit limit on your credit card is not your money; It represents how much money the credit card company and your bank are willing to lend you.
In return for using the credit limit on your credit card, you must pay interest on your purchases, after a grace period of about one month.
The average annual interest rate on a credit card is 17.03%, as of August 22, 2018, according to industry data.
While paying your balance in full every month can help you dodge interest payments, carrying a balance can cause your statement to increase rapidly. And contrary to popular belief, carrying a balance won’t help improve your credit score.
Another difference between credit cards and debit cards are the associated rewards and benefits. For example, many credit cards offer rewards in return for using their card to make purchases. These perks and rewards can take the form of cash-back, airline miles, purchase protections, or points that can be redeemed for gifts.
When you should use a credit card vs. a debit card
Knowing when to use each type of card can help you make sure you’re making a wise decision regarding each purchase.
Debit cards are typically great for day-to-day purchases that are baked into your monthly budget. Since you have the funds in your checking account, you can usually rest easy knowing that you will not go into debt making planned purchases. However, if you spend more than you have in your account, your bank might charge you overdraft fees.
Credit cards, however, can have their time and place. It may be worthwhile to make some purchases using your credit card to take advantage of cash back and other reward incentives. If you know that you have the money to pay for an item you’ve purchased, using a credit card and paying it off in full before the next due-date can net you rewards while avoiding any additional interest.
Extended-warranties on big-ticket purchases can also be a benefit that some credit cards offer. Other credit cards might even provide insurance for vacations or car rentals that are purchased using the card.
How a debit card can help you budget
By using a debit card for the bulk, if not all of your expenses, you are choosing to use your own money rather than borrowing. That allows you to forego the additional interest that would be incurred when you use a credit card and don’t pay off your balance each month.
If you are able to create a budget and follow it by spending only the money you actually have, you can begin to save, tackle your debt, and even start to invest in your future.
You can reserve your spot for the debit account today.
If you aren’t a Stash investor already, you will need to download the app and register for a Stash Invest account. Then you will need to sign up on the waitlist to apply for a Stash Debit Account. Account Opening for Banking is subject to Green Dot Bank’s approval.