Many young folks, especially those that haven’t been in the US that long, conflate debit cards with credit cards. Debit cards have almost nothing in common with credit cards despite their similar physical appearances.
Debit cards are essentially the electronic replacement of paper checks. Instead of writing checks to pay for your groceries, you swipe a debit card. And instead of signing checks, you enter a PIN. The major difference is in the processing. Your debit card is directly connected to your checking account, and payments processed through a debit card posts to your checking account right away, while a check needs to be cleared by the Automated Clearinghouse (ACH) system of the Federal Reserve Banks, a process that may take days.
Credit cards are totally different. Credit card is a revolving debt account and by default is not connected with your bank accounts. Credit cards do not require PIN’s, and payments made through a credit card post on the credit card account. You haven’t spent any money yet until you make a payment from your bank account to the credit card. This is an important distinction. You can refuse to pay a charge on your credit card; with a debit card, the money would be withdrawn right away.
Due to the separation of credit cards from banking accounts, credit cards are considered a debt instrument, and thus help you build credit. Debit cards do not help you build credit because the money is paid right away – what is there to owe?
Due to the separation, it is also safer to pay with credit cards. If you detect a suspicious purchase on your credit card statement, you can refuse to pay for that transaction, and have your credit card issuing bank to deal with the suspicious transaction. Often, banks allow you up to 60 days from the statement closing date to dispute a charge. But don’t abuse this feature: if your disputed transaction turns out to be legitimate, you will still be charged.
As alluring as credit cards sound, there are several downsides to come with it. Because of its nature as a debt instrument, you typically need some previously established credit history to get one. If you don’t, I have put together a list of options for you: http://hiepsfinance.com/credit-builders/applying-for-credit-cards/
That isn’t a big deal; given enough time you’ll have a solid credit history that allows you to get just about any credit card on the market you want.
What’s the real problem with credit cards? Well, the fact that they are a debt instrument makes it tempting for people to make big purchases on them and refuse to pay. By doing this, they bring peril to the credit-issuing banks as well as to themselves: their credit history will reflect the bad credit behaviors, blocking them from obtaining any type of debt, including mortgages, in at least several years. Unfortunately, many American consumers these days lack the discipline to live within their means. With credit cards, they buy things that they normally can’t afford: a nicer car, a yacht, that hot tub, etc…. It doesn’t help that credit cards usually have very high APR’s. Interests accumulate very fast, making credit card debt harder to pay the longer you wait.
I have established a habit of always paying credit card balances in full; therefore I do not pay any interest and always live within my means. I know the money doesn’t come out of thin air; eventually my checking account will be hit if I don’t control my spending. And as such, I take full advantage of the advantages of credit cards, and don’t get myself into financial trouble.
If you’re young like me and still learning how to manage your finance, I hope you successfully establish healthy financial habits and be comfortable using your credit cards. But if you find yourself struggling to control spending, perhaps a debit card is a more suitable option.
Richard (Hiep Tran)