Have you ever made a purchase without paying up front? If so, you are likely already familiar with the concept of credit.
Credit, defined in financial terms, is essentially the means you can make a purchase before providing payment. Credit systems rely upon the obligation of the customer to pay in the future. While small neighborhood stores may extend credit to frequent customers backed only by trust, formal credit obligations like credit card debt are legally binding.
Let’s look at some key terms in the credit space before exploring the differences between credit cards and debit cards. Understanding these concepts will give you a leg up in building a positive credit score and using credit and debit cards effectively.
Credit Cards vs. Debit Cards
Credit and debit cards have become so ubiquitous over the past decade that there’s a good chance you have one or both in your pocket as you’re reading this. At the most basic level, you might know that credit cards are better for making day-to-day purchases and debit cards are best for withdrawing from the ATM and not recommended to be used online, but it’s important to understand the reasons why.
The Major Differences Between Credit and Debit Cards
First of all, credit cards and debit cards draw funds from completely separate sources. Credit cards earn their name by posting charges to your personal line of credit. That is, you are using someone else’s money with a promise to pay it back. Debit cards, meanwhile, withdraw directly from your bank account.
Since debit cards enable near-instantaneous withdrawal of funds, they do not provide credit in the way that credit cards do. The money you spend through debit cards is your money currently in your bank account, therefore interest rates do not apply for debit card transactions.
In the case of credit cards, a certain interest rate will be applied to balances carried over time. No interest will be charged if you can pay off the outstanding credit balance within each billing period (usually one month), making credit cards a convenient way to shop without carrying around lots of cash.
Credit cards are also useful in financing large purchases that you would like to pay off over time rather than all at once. As with any form of debt, you should be careful to ensure that you will actually have the means to pay off the outstanding debt plus whatever interest accumulates in the intervening time.
Which Card Is Right For You?
Credit cards and debit cards each have their own distinct uses and complement each other well. Since both can be used on smaller everyday purchases, perhaps your temperament should be the best indicator for which is best for you to carry around for such a purpose.
If you are a spender and tend not to consider the price relative to your means to pay for it, using a debit card is recommended so that you cannot spend more than you have. On the other hand, those with shopping and budget discipline could benefit from using a credit card even on small items and gradually earning any rewards offered by the particular card such as: travel airfare or hotel points.
Actively using a credit card is also a great way to build up a positive credit score, although this can also work in reverse if you fail to make payments on time. Having a strong credit score and knowing what is a good credit score are both very useful when trying to finance major purchases like a home or automobile loan.
It should also be noted that you would do best to use credit cards for online purchases. While debit cards can be used online, it is not advised since the money comes directly from your bank account. As a result, it is more difficult to dispute unauthorized transactions if someone else somehow gains access to your account. Credit cards are better in this case because they come backed with guarantees against liability for fraudulent transactions, which will be very welcome if the worst happens and your card information is stolen.
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