Knowing the differences between credit and debit cards can help you use each type of card to your advantage.
While credit and debit cards look similar at first glance, their functions — and advantages — are very different. Knowing when to use each type of payment card can give you a leg up in your financial life, so keep reading to learn about the differences between debit and credit cards and make sound decisions regarding spending.
What is a credit card?
A credit card is simply a line of credit that an issuer extends to you. You can use it to borrow money to buy things, transfer balances from other credit cards or, in dire circumstances, get a cash advance. When you get a credit card, you agree to pay that money back, with any interest you might have accrued, in the future.
When you make a purchase with a credit card, you use a portion of that card’s available credit. How much the bank allows you to borrow at one time (also known as your credit limit) will vary depending on your credit history and credit score.
You’ll receive a bill once a month, and you’re required to make at least a minimum payment. If you don’t make that payment in a timely manner, you’ll likely get hit with a penalty fee — and your credit score will suffer.
Interest rates are high on credit cards: The average credit card rate currently sits above 18 percent. You could end up paying a lot in interest depending on how much of your balance you carry over from month to month.
Advantages of a credit card
- Build your credit score: If you use them responsibly, credit cards can help you boost your credit score. A record of on-time payments will steadily improve your credit score. If you pay your bill on time your score should remain steady but be careful about carrying balances. That could increase your credit utilization ratio (the amount of credit you’re using divided by the total amount available to you), which counts for 30 percent of your FICO score.
- Improve security: Credit cards offer a safer way to make purchases than debit cards. If someone steals your debit card number, they can immediately withdraw funds from your checking account. Scammers can also steal your credit card information and use it to rack up unauthorized charges in your name, but they don’t have immediate access to your money, which will give you time to dispute the charges. In addition, most major credit cards come with zero liability policies.
- Earn rewards: Using credit cards can help you build up valuable rewards like cash back and travel points, which you can’t do with most debit cards.
Disadvantages of a credit card
- High interest rates: If you don’t pay off your credit card balance in full each month, you’ll get stuck paying interest, which can cause your debt to grow quickly.
- Fees: Credit cards typically come with fees for making late payments. In addition, many come with annual fees just for using them.
- Can lead to debt: If you charge more than what you can afford to pay, you can end up with a pile of credit card debt that keeps growing, thanks to those pricey interest charges. And that debt can damage your credit score.
Cash back credit cards
If you hear the term cash back credit card, that generally means that the credit card’s reward structure focuses on cash back instead of other rewards like airline miles. That’s not to say a cash back credit card can’t offer other perks, but the main advantage of that card is likely a high rate of cash back on common purchases like groceries, gas, and dining.
The way a cash back credit card works is that you get a percentage of cash “back” whenever you make a purchase. Usually, cash back credit cards offer a flat rate of cash back for all purchases, like 1 percent, and then higher percentages for select spending categories like travel. You can usually choose to have your earnings deposited into your checking or savings account or to apply them as a statement credit to your card balance.
Many cash back credit cards have rotating bonuses where every month or quarter they offer more cash back than usual for a select category. Because of this, it can be helpful to plan your purchases around your card’s bonus offers when possible.
What is a debit card?
A debit card is a payment card connected to your checking or savings account that “debits” money directly from that account when you use it to purchase something. You can also use your debit card to withdraw money from your checking or savings accounts through ATMs.
One good thing about a debit card is that it doesn’t allow you to spend more than what is currently in your bank account. On the other hand, it lacks certain perks that credit cards have.
Debit cards are also riskier than credit cards. Remember: If a hacker steals your information, they can basically drain your bank account. You might eventually get the money back after reporting the crime, but it could take some time.
Advantages of a debit card
- Helps stop overspending: Paying a credit card 30 days or more late can cause your credit score to plummet — and if you carry a balance from month to month, the high interest rates can wreak havoc on your finances. If you struggle with budgeting, paying your bills on time or overspending, it might make more sense to pay for purchases with a debit card.
- Good for small purchases: If you don’t like to carry cash with you but want to be able to make small purchases without using a credit card, a debit card can really come in handy.
Disadvantages of a debit card
- No rewards: Debit cards don’t usually offer rewards, so you don’t have opportunities to earn cash back, points or travel miles with them.
- Can’t build your credit score: Because a debit card uses your own money instead of credit when you make purchases, using one won’t help improve your credit score.
- Less secure: Debit cards are directly linked to your bank account, so they can be less secure than credit cards.
Major differences between a credit and debit card
Keep in mind the most important differences between the two types of cards:
- Cash vs. borrowing: The most important difference between a debit card and a credit card is that a debit card uses your own money when you buy things and a credit card enables you to borrow money for each transaction you make.
- Potential to earn rewards: Another major difference is that credit card issuers typically offer valuable rewards to their cardholders but debit cards don’t typically come with any flashy perks.
There are advantages and disadvantages to using debit and credit cards. Which one you’ll want to use will depend on the purchase you’re making and your financial preferences. Now that you know what the advantages of each payment method are, think before you pay so you can make strategic spending decisions.