Credit. Debit. Two very different ways to spend money.
How do they work and how can they help us reach our goals?
“Credit or debit?”
We hear these words all the time when making purchases. What’s the difference and why does it matter?
We have so many ways to spend money today – with the flick of our wrist, our watches can be used at grocery stores and elsewhere to make speedy purchases. But how do these transactions work and how can we make sure we are using the best methods to help us reach our goals?
Let’s start by defining the two.
A debit card transaction withdraws money directly from your bank account at the time you make the purchase. This means you need to have the money in your account at the time of the transaction or it will be declined. You don’t have to pay any interest on the amount because the money is yours. Think of it like walking up to the ATM or a teller station at the bank and withdrawing the cash, then walking to the store and spending it.
A credit card transaction, on the other hand, is a loan. You are using someone else’s money to make your purchase and, as long as you stick to your approved amount (the credit limit), you can spend as much as you want without getting declined. Then, once a month, you will get a bill to pay back what you borrowed. If you pay the whole amount, there is no charge, but if you only pay part of what you borrowed, you will pay interest on the rest. And the average interest rate is currently around 17%!1
What about things like Google Pay, Apple Pay, and Venmo?
It depends on how you have them set up. If you have linked your checking account or debit card to one of these digital platforms, then it is the same as using your debit card for those transactions. Likewise, if you link your credit card, then it is the same as using a credit card. One other thing to keep in mind is when people pay you using services like these: If you leave the money sitting there, the digital platform is earning money on your money, instead of you.
So, which is better?
Well, it depends on what your goals are.
Debit cards make it more difficult to spend money you don’t have – and can help you stick to your savings and spending goals because you see the money disappearing as you spend it. There are even cool tools like QuickSaver, which rounds up each debit card purchase you make to the nearest whole dollar and transfers the difference into your savings account – helping to save even more.2
Credit cards can be a useful tool as well, if managed correctly. They can help you build a positive credit history (proof when you want to get a larger loan, like a mortgage, that you are trustworthy). However, if managed poorly, it will do the opposite because any missed payments or other issues with affect your score and the same things that makes them so easy to use (not having to worry about whether or not there is enough money in your account), is the very thing that may cause you problems when it is time to pay it back. The fact of the matter is, it is much easier to lose credit than to gain it.
So, if your goals are to save money and get a better handle on your spending habits, stick with the debit card, but if you are doing well in these areas are looking to make a large purchase that may require funding assistance, consider responsibly using a credit card.
You may have noticed we didn’t talk about fraud protection at all. That’s because both credit and debit cards come with fraud protection. But, if you’d like to hear more about fraud, check back next week for the final portion of our Financial Literacy series when we talk about identity theft and safety!
2 The change will be combined and a single transfer will be made at the end of each business day your card is used. There is no charge for the QuickSaver feature. See your Account Agreement and Disclosures for terms and conditions for deposit accounts. Upon enrollment, we will round up your MasterCard® debit card purchases to the nearest dollar and transfer the difference from your checking account to your American Riviera Savings or Money Market account. If the account enrolled in QuickSaver is converted to a checking account, QuickSaver transfers will continue to be made into that account. If you do not currently have a Savings or Money Market account, we will contact you to open one. We may cancel or modify the QuickSaver service at any time without prior notice.Next: When things go terribly wrong: Fraud