Now that we have officially reached the halfway point of 2019, there is no better time to stop for a “breather” and take stock of your total wellness — and that includes your spending habits and how they factor into your progress toward your year-end goals. This brings us to a few questions we receive quite often here at The Humphreys Group: What should you actually use to make purchases? Are debit cards the “safer” method, or do credit cards rein supreme?
Our Financial Planning Associate, Hallie Kraus, is shedding light on the debate in a new, two-part blog series. Scroll down to read Part I, and then catch Part II here.
“Credit or debit?” We’re asked this question all the time at the register – but which payment method is actually best to use? And what’s the true difference between the two?
Let’s start with a basic recap: Debit cards are directly connected to your checking account. When you make a purchase, funds are withdrawn from that account immediately and transferred to the merchant.
Credit cards, on the other hand, are connected to a line of credit from your bank. When you make a purchase, you’re borrowing funds from your bank to pay the merchant. If you don’t pay off everything you owe each month, your bank will charge you (usually very high) interest on the remaining balance.
When Is It Best to Use a Credit Card vs. a Debit Card?
When you want to build your credit. If you’re planning on buying a home or car, lenders first want to see that you have a good credit history. And when you use a credit card, your balance and history of payments is reported to a credit bureau each month, creating a record — and, essentially, a narrative — of your financial habits and trustworthiness to lenders. Using a debit card is not reported to credit bureaus and therefore doesn’t create any sort of history.
Of course, simply using your credit card alone doesn’t help your credit; what matters is if you use it responsibly. If improving your credit is truly a priority for you, make sure to keep your credit card balance below 30% of your limit (for example, if you have a $10,000 limit, keep the balance below $3,000). You’ll also want to pay off the balance in full, and most importantly, pay your credit card bill on time every month. Not doing any of the above will negatively impact your score and thus be counterproductive.
When you want to minimize your fraud liability. This is perhaps the most compelling reason to use a credit card. Firstly, when a fraudster uses your credit card without permission, they’re technically stealing money from the bank that issued you the card — not from you personally. But what you may not know is that credit cards also offer more robust fraud protection.
Thanks to the Fair Credit Billing Act (FCBA), if you report unauthorized charges to your card issuer within 60 days, your liability for fraudulent transactions is limited to $50. Even better, the vast majority of credit card companies (Visa, MasterCard, American Express and Discover) have a zero-liability fraud policy. Essentially, assuming you report credit card fraud promptly, you will probably never pay for unauthorized transactions.
In contrast, when a fraudster uses your debit card, they have immediately stolen money from your bank account. And although debit cards have their own set of protections through the Electronic Funds Transfer Act (EFTA), they are much less robust. According to the EFTA:
- If you report a fraudulent debit card transaction within two business days, your liability is limited to $50.
- If you wait longer than two days to report the fraudulent transaction, you can be liable for up to $500.
- If you wait longer than 60 days to report, you could be held liable for the entire fraudulent transaction. So, depending on how much the fraudster has used your debit card, and how diligently you check your transaction history, your damages could be unlimited.
But there is one workaround: If you strongly prefer using a debit card, but want to achieve the same level of fraud protection as a credit card, select “credit” when you run the debit card. This requires the bank to follow credit card rules: Rather than being withdrawn from your bank account in real time, the purchase will go through the credit card network, and funds will be withdrawn within a few days. But the key distinction is that the transaction will be covered by the card company’s zero-liability policy, thereby exempting you of responsibility for unauthorized transactions.
When you want to earn rewards and have a good handle on your spending. Banks love to offer credit cards with cash back, points or other rewards, and it’s easy to see why. When rewards are connected to how often we use a credit card, we as consumers are incentivized to use them more often. The banks are essentially betting that, in our quest for more rewards, we will charge more to the card than we can pay off in one month, so they can charge us interest on the remaining balance.
That said, when used responsibly, rewards credit cards can save consumers a decent amount of money. If you want to use a credit card for this reason, make sure you never use the card for something you can’t afford in cash, and of course, pay off the balance in full every month. It’s also worth periodically doing the math to double check that your rewards exceed any annual fees associated with the card. If you’re paying the bank interest every month, or have sky-high annual fees, the credit card is not worth it, regardless of its rewards or other benefits.
Click here to read the second installment of Hallie’s two-part series, in which she discusses the benefits of using debit cards over credit cards and shares some helpful resources you can use to practice smart spending all-year-round.