Debit card may look the same, feel the same, function the same, even have the same logo as a credit card but there is a world of difference between the risks and rewards of a debit card vs. a credit card. Contrary to popular belief, debit cards are not simply credit cards with training wheels and credit cards are not simply debit cards with rewards. Read on to find out why.
How debit cards work
Debit cards are also known as check cards, because they essentially do what the old-fashioned paper checks (you know, the ones you get from grandma for your birthday?) used to do. When you swipe your debit card at the mall or grocery store, the amount is automatically deducted from your checking account as if you had written out a check for that amount. You can either punch in your pin number or sign as if you were using a credit card.
Debit card risks
The risks involved are the same as with a checkbook. You must be sure to have enough money in your checking account at all times to cover your purchases, or you may risk overdrawing. Some banks offer overdraft protection, but most will charge a hefty fee for spending more than you have. Though there is a little bit of wiggle room from the time you swipe your card until the time the transaction processes, its generally very unwise to spend more than you have in your account.
Debit card fees and rewards
Occasionally, a business will charge you a $1 to $3 fee for using your pin, especially at ATMS. While this may seem like chump change, it can add up. Especially when you factor in that your bank may charge you additional fees for using a different bank's machine. So, if you make four transactions or withdrawals a day with two $2.50 fees each, that's $20 you are just giving away.
More and more debit cards are offering rewards similar to credit cards; point systems or cash back rewards that match each dollar you spend. You can often get extra points for spending at certain vendors. Simply swipe your credit and choose credit instead of debit and sign instead of entering your PIN.
How credit cards work
Credit cards are familiar sights from commercials where anything is possible with plastic to movies where adolescents break the bank with their unbridled spending. The truth about credit cards is somewhere in-between, that is if you play your cards right. Each time you use a credit card, you are essentially taking out a loan from your credit card company. At the end of the billing period (usually a month) your credit card will send you a balance of how much you owe and how much you need to pay off immediately.
Credit card risks
The downfall of credit cards is that you can often end up paying much more than what you spend. Unless you pay off your entire balance each month, your debts will accrue interest, meaning it's actually possible for your debt to grow- even though you are making the minimum payments.
Missing a payment, having too much debt, or worse, defaulting can have lifelong effects on your credit as well. When you are looking to make a large purchase--a car, a home, an education--lenders will look at your credit score before deciding how much to give you (if any) and on what terms.
The biggest risk of credit cards is getting stuck in a cycle of debt. Keeping a balance leads to interest, which leads to a larger balance which in turn leads to more interest, etc. Therefore, its of utmost importance to keep your debts under control.
Credit card fees and rewards
Credit cards were the first to offer point-based reward systems. Depending on how much you spend and where you spend, you can accumulate points that can be traded in for cash, gift certificates or frequent flyer miles.
The fees involved with credit cards can be quite vexing. For example, for using the deceptively convenient cash advance, you can end up paying increased interest for a longer amount of time than if you would've just swiped your credit card at the register.
Deciding to use a credit card or a debit card is hardly ever a matter of one or the other. Different situations call for different cards. However, though some say you need credit cards to build up your credit, this is only half true. While credit cards do put you on the credit radar, a much safer and better way to build credit is with larger purchases--such as auto loans and mortgages--which do not require credit cards.
One preferred method is the one-two punch. Using a credit card to get the reward points and then paying off the entire balance every month with a debit card is an excellent way to get the benefits of credit cards as well as learning how to manage your spending.
Always remember this golden rule of spending: never buy something you can't afford. Its much better for your credit rating, your wallet and your mental health to live in the black instead of the red.
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