Debit cards have become Americans' first choice among noncash payment methods -- surpassing check-writing for the first time ever, according to a new study released by the Federal Reserve Wednesday.
Credit card usage actually declined slightly for the first time -- a casualty of consumers spending and borrowing less during the recession, banks tightening credit and of an avalanche of negative sentiment toward abusive credit card practices that led many Americans to close their accounts or stop using their credit cards.
"Credit cards are viewed with distrust by consumers after all the shenanigans ... but it seems likely that the poor economy has shown people that credit should be saved for emergencies and not just used for things you don't really need and can't really afford," Linda Sherry, national priorities director for Consumer Action, said in an e-mailed response. "The best thing about debit cards is they require discipline, to pay as you go, and keep your checking account in balance."
The Fed's payments study is published every three years and tracks trends in how people pay for retail merchandise. The study estimates the total number and value of payments made between 2006 and 2009 using checks, debit cards, credit cards, automated clearinghouse (ACH) payments (electronic checks often used to process recurring payments) and prepaid cards. The study also reviewed the value and number of ATM withdrawals during the same time period.
According to the Fed study, debit card use experienced the largest increase in the total number of transactions than any other payment type between 2006 and 2009. Shoppers used debit cards 12.9 billion more times in 2009 than in 2006. When not paying with cash, Americans used, in descending order:
During the study period, the number of transactions using checks declined by 20 percent, continuing a steady slide away from paper checks that began nearly 20 years ago. Debit card transactions, on the other hand, rose 51.6 percent, prepaid card use increased by 81.8 percent and ACH payments went up 30.8 percent. Credit card use declined by 0.5 percent.
Richard Oliver, executive vice president of the Federal Reserve Bank of Atlanta, which sponsored the study, said in a press release the results show how much electronic payment processing of all payment methods has advanced. He added: "It is also likely that the results reflect changing consumer behavior during difficult economic times."
Why the rise of debit cards? Debit cards are plastic payment cards that are linked to either checking or savings accounts. Unlike credit cards, which allow users to borrow funds to complete purchases, debit cards tap into a user's own money reserves when making transactions. They have ascended to the No. 1 noncash payment method as people don't want to carry cash and like the convenience of swiping a card. The debit card can help those who budget keep track of how much they spend each day by keeping an electronic record.
Debit cards are also the payment method of choice for people with bad credit who have difficulty getting credit cards. In addition, they are preferred by people who want to avoid using credit cards, and those who receive government benefit payments and payroll checks that are directly deposited into their bank or credit union accounts.
Card industry observers have noted that banks and credit unions are shifting their revenue-generating focus more toward debit and prepaid cards and away from credit cards. The Credit CARD Act of 2009 severely limited lenders' ability to increase credit card interest rates and fees. Debit cards and prepaid cards have fewer restrictions for issuers and lenders have started marketing them more aggressively in recent months.
Unequal protections Consumer groups, however, have put the word out to card users that debit cards and prepaid cards do not carry the same consumer protections as credit cards and may be loaded with fees. Purchases made with debit or prepaid cards do not carry the same protections as credit cards if there are disputes with merchants about defective products. A credit card issuer can withhold payment to the merchant until the dispute is resolved. Debit cards carry no such safeguards. In addition, the card users' liability for losses if cards are lost or stolen can be greater with debit cards than credit cards.
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"The fact that more and more people are using debit cards means we have to step our efforts to teach consumers about the differences in potential personal liability between debit and credit cards," said Sherry, from Consumer Action. "It's also so important to remind consumers that your debit card is linked to your checking account and probably your savings account, which makes the downside of lost or stolen funds that much greater."
Debit cards also can be subject to overdraft charges if users attempt to spend more than they have in their accounts. New Fed rules that took effect July 1, 2010, require banks and credit unions to get customers' permission -- called "opting in" -- before enrolling them in overdraft protection programs. The fees can range from $29 to $35 if card users overdraft their accounts.
Leslie Parrish, a senior researcher for the Center for Responsible Lending, urged debit card users not to opt in for overdraft. "Because of the high fees that banks charge to cover debit card purchases that would otherwise simply be declined at no cost, a debit card with overdraft coverage can be a much more expensive option than a credit card," Parrish said. "We urge consumers that are trying to minimize their debt to protect themselves from these fees by not opting in."
Because of the high fees that banks charge to cover debit card purchases that would otherwise simply be declined at no cost, a debit card with overdraft coverage can be a much more expensive option than a credit card.
-- Leslie Parrish
Center for Responsible Lending
Ed Mierzwinski, consumer program director for U.S. PIRG, a federation of state Public Interest Research Groups, notes that "banks have cleverly substituted debit (and prepaid) for cash, to keep interchange revenue up."
"While the overdraft rules have helped, the regulators should have gone further. Consumer groups believe that all payment methods -- debit, payroll, prepaid, Internet and the emerging mobile payment systems -- should have upgraded rights," says Mierzwinski.
He said that the impending startup of the new Consumer Financial Protection Bureau may lead to better payment card protections. The agency was approved as part of the massive Wall Street Reform law, but won't be open for business until mid-2011. Among its powers: writing and enforcing rules to protect consumers from unfair and abusive lending and financial practices.
Credit card use declines Consumers' disfavor with credit cards has been broadcast in monthly G.19 reports, which are issued by the Fed and track outstanding revolving debt. The latest report, issued Dec. 7, 2010, shows consumer credit card balances have fallen for 26 straight months. The Fed's payment study echoes what's reflected in the G.19.
"This is the first time since we've been doing these studies that there has been a decline in credit card payments," said June Gates, public information manager for the Federal Reserve Bank in Cleveland. The Fed began tracking payment methods in 2001.
Ken Paterson, vice president of research operations for the Mercator Advisory Group, a card industry research firm, said the decline in credit card use is a function of two things: "There are people who decide not to use the card or to cancel their accounts. There are people who have had their accounts canceled for them because they have problems," Paterson said. "A significant part of that decline is lenders cutting back on inactive accounts, past due accounts and charged off accounts."
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