Credit Cards vs. Debit Cards: The Differences Can Add Up

When you plan to make a purchase, it’s important to know whether you’re using debit or credit. While these cards look similar and function much the same at the cash register or when buying online, they work very differently. 

Debit cards take money out of your bank account when you swipe, while credit cards add debt to your line of credit when you use them. Understanding the differences between debit cards vs. credit cards will allow you to use the right one for your needs.

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In this article, we’ll cover:

• Debit cards & how they work
• Credit cards & how they work
• Key differences between the cards
• When to use debit vs credit cards

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What is a debit card?

A debit card is issued by your bank in conjunction with your checking account. It allows you to make purchases with the money in your account. You could think of a debit card as being a plastic version of cash; every time you use it, the bank deducts the funds from your checking account balance.

How debit cards work

When you make a debit purchase at a cash register, you’ll usually need to enter the personal identification number (PIN) associated with your card, though you won’t need to do so when paying online. At some merchants, like supermarkets, you can even get cash out of your bank account when you make a debit card purchase and use your PIN.

Benefits of debit cards

A debit card can come in handy for making purchases without worrying about spending beyond your means. It can be more convenient and secure than carrying a lot of cash or writing checks. Other benefits of debit cards include:  

• Security: If someone stole your debit card, they’d usually need your PIN to make in-store purchases, which adds an extra layer of security. Debit cards can also be more secure than cash since the bank will block transactions if you report your card lost or stolen.
• Potential rewards: While not very common, some debit cards offer rewards programs that allow you to earn things like cash back or points you can redeem for products when you use your debit card.
• ATMs: If you need cash, you can use your debit card to withdraw it from your checking account at an ATM. Often you can check your account balance and make deposits at an ATM too.
• Faster payments: Debit card purchases made with a PIN usually process very quickly, usually within 24 hours or less, which can be helpful when keeping close track of your spending.
• No interest charges: When you use a credit card, you’re racking up debt, and you’ll have to pay interest on what you borrow at a certain point. Because a debit card is withdrawing money from your checking account, you never have to worry about paying interest.
• Spending management: Sticking to your budget means spending only the money you have. Your debit card limits you to the amount in your checking account, so you’re less likely to spend beyond your means.

Cons of debit cards

Because a debit card takes funds out of your bank account, the biggest drawback tends to be the risk of overdrawing your account. You also don’t have the flexibility of a line of credit if you need to make larger purchases. Here are some of the disadvantages that can come with a debit card:

• Overdraft fees
• Transaction processing order
• Other fees
• Keeping track of other debits
• Spending limits
• Limits on fraud protection

Overdraft fees

It is possible to spend more money than you have in the bank when using your debit card, and that can incur overdraft fees. While your card may simply be declined if you don’t have the funds in your checking account, there may be times when an earlier transaction hasn’t finished processing, so your purchase goes through at the register, but your balance actually goes into the red when all the transactions are processed at the end of the day.

Transaction processing order

Banks often process all the transactions for your checking account, including deposits and debit card transactions, in a single batch overnight. But they don’t necessarily process them in the order they were submitted. Some banks engage in what’s known as debit resequencing, in which they process withdrawals before deposits. For instance, if you have direct deposit for your paychecks, a bank could process all the debit card transactions you made on payday before processing your paycheck deposit; that can lead to overdraft charges in some cases. 

Other fees

Debit cards generally have fewer fees than credit cards, but some banks tack on fees for things like getting cash at the register or making purchases in foreign currency. Banks may also charge fees for using ATMs; even if the bank offers free ATM withdrawals at its own ATMs, you may pay a fee for using ATMs outside that network.

Keeping track of other debits

A debit card isn’t the only way money can come out of your checking account; you might use paper checks or have automatic withdrawals set up. That means you need to be aware of other charges that might process on the same day that you’re making purchases with your debit card to ensure you have enough funds in your account for all expenses.

Spending limits

The fact that you’re limited to spending the money you have in the bank can be a good thing for managing your spending. However, if you need to make a larger purchase that you don’t have the money for at the moment, a debit card won’t allow that flexibility

Limits on fraud protection

There are federal laws that limit your liability for unauthorized transactions if your debit card is stolen. How much you’re liable for is based on how quickly you report the theft, and the protections are less robust than those for credit cards. 

What is a credit card?

A credit card is a line of credit issued by a financial institution; every time you use the card, the amount you spend is money you’re borrowing from the institution. Most cards come with a credit limit, which is the maximum amount you can owe at any given time.

How do credit cards work?

On a basic level, a line of credit is a loan: When you borrow the money, you’re required to pay it back, usually with interest. But unlike a loan, where you borrow a certain sum upfront and pay it back in installments, usually over a set period of time, a line of credit is an amount of money you can borrow at any time. When you open a credit card, your credit limit is the maximum amount you can borrow; when you swipe your card, you tap into that line of credit. Essentially, you’re borrowing whatever amount of money you just spent. 

Banks determine your credit limit based on factors like your credit score, credit history, and income. You’re required to pay back a certain amount of your balance each month, and you’re charged interest on any balance you carry forward. 

Interest rates on credit cards vary widely. The average credit card interest rate was 16.65% as of May 2022, but multiple factors go into determining the specific rate your card has. Banks might offer different interest rates to consumers based on their credit scores. Many banks also offer cards with a low or 0% introductory rate, which remains in effect for a certain time before going up. If you pay your bill late, the financial institution may raise your rate in addition to charging a fee.  

Benefits of credit cards

Credit cards come with many useful features, and banks often offer appealing incentives with certain cards:

• Strong fraud protection: Credit cards offer stronger protection against fraud than debit cards; the Fair Credit Billing Act (FCBA) limits your liability to $50 for fraudulent charges. Many credit card issuers also offer additional purchase protections.
• Rewards: While some debit cards offer rewards, a much larger number of credit cards do so, and the perks are often better. You might find cards that give cash back, frequent flier miles, or points you can redeem for a variety of things.
• Additional perks: Many credit cards entice customers with added perks, including things like extra cash back or points on certain kinds of purchases, discounts or special pricing on some products, extended warranties, travel insurance, sign-up bonuses, and more.
• Grace period: When you make a purchase with your credit card, you have a grace period, usually around 21 days, before you have to either pay it back in full or it starts accruing interest. This can give you the flexibility to buy things you don’t currently have the funds for or cover an emergency, but keep in mind that this flexibility can lead to spending beyond your means if you don’t have a clear plan for paying off the balance in time.
• Opportunity to build credit: Your credit score is made up of many factors, and how you use credit cards can play a part. The length of your credit history is one factor, so if you have a credit card account in good standing for a long time, it works in your favor.

Another important consideration is what’s known as your credit utilization ratio: the amount of credit you have available compared to how much you’re using. For example, if you have a credit card with a $5,000 credit limit and don’t carry a balance, you’ll have a better credit utilization ratio. A word of caution: while having a credit card and using it wisely may help build your credit, it can also open the door to things that harm your credit score, like late payments or high balances.    

Cons of credit cards

A credit card is, essentially, a loan, and it comes with all the downsides associated with taking on debt, as well as potential fees. Here are some of the disadvantages associated with credit:

• Interest charges
• Late fees and penalties
• Potential annual fee
• Other fees
• Risk of credit card debt

Interest charges

It can be easy to forget that the money you put on your credit card is a loan, and you’ll pay interest on every dollar you don’t pay back at the end of the month. The average interest rate on credit cards is quite high compared to other forms of debt, and you’re also charged interest on the interest your account has accrued. That can compound quickly.

Late fees and penalties

Paying your credit card bill late will usually incur a fee. The law limits the fee to no more than $29 for your first late payment, but after that fees can be as high as $40. You can also lose the ability to earn rewards or perks if you pay late and the card issuer may increase your interest rate.  

Potential annual fee

Some credit cards charge an annual fee just to have the card, no matter how much you use it. Sometimes the fee is worth it, especially if you earn cash back or other rewards that are worth more than the annual fee. But if you don’t use the card much, you may wind up spending money on a fee without any benefit.

Other fees

There are a variety of other fees you may encounter with a credit card, including charges for foreign transactions, balance transfers, and cash advances. You may also be charged a returned payment fee if you don’t have enough in your bank account when your monthly payment is processed.

Risk of credit card debt

Perhaps the biggest downside of credit cards is how easily you can build up debt that takes a toll on your finances. While people open a credit card intending to pay off the full balance every month or make a one-time large purchase they plan to pay off quickly, the temptation to spend more can be tough to resist. And if you run into a financial emergency, like losing your job or totaling your car, you may find yourself with a credit card balance you can’t pay off quickly. The longer you have a balance on your credit card, the more interest builds up, and the deeper into debt you go. 

Credit cards can have a useful place in your financial toolbox, but responsible spending is key. Regardless of your credit limit, if you borrow more than you can reasonably repay or forget to make payments on time, the benefits of a credit card can quickly become liabilities. You may wish to get a free copy of your credit report each year to ensure your credit card usage is contributing to a healthy credit score. 

Debit vs credit: key differences

The key difference between credit and debit cards is where the money comes from. When you use a debit card, you’re using your own money. When you use a credit card, you’re borrowing from a bank. And the loan comes at a price. 

When to use debit vs credit for purchases

You don’t have to choose a debit card vs. a credit card; you may find that having both is beneficial. Sometimes, using your debit card is a wise move, and for certain purchases, a credit card can be a smart choice. 

When to use your debit card

If your goal is to live within your means, a debit card can be ideal for day-to-day spending. Because you can only spend the money you have, your debit card can help you stick to your budget. Consider using your debit card as your go-to for things like: 

• Necessities like groceries, gas, and medications
• Discretionary spending like entertainment and shopping
• Paying friends through an online payment app to avoid the higher fees apps charge for credit card transactions   

There are also certain situations when a debit card can be a smart financial choice:

• Some small merchants charge a processing fee for credit card transactions, but not debit card purchases. Your debit card will save you money in those instances.
• If your debit card comes with rewards, pay attention to the kinds of purchases that earn you the most points or cash back to take advantage of the perks

When to use your credit card 

Certain kinds of purchases are particularly well-suited to the features of a credit card. As long as you’re spending within your budget, you might want to opt for credit for things like the following:

• Hotels: When you book a hotel, you have to put down a deposit that will be reversed when you check out, and the deposit may be more than the actual cost of your stay. If you put that charge on your credit card, you won’t have to worry about your bank balance being reduced in the meantime.
• Reimbursable expenses: If you’re paying for something you expect to be reimbursed for, such as a work expense or covering the tab at dinner with friends, you might want to use your credit card so that you’re not deducting all that money from your checking account. Be sure you’ll be reimbursed before the expense you put on your credit card starts accruing interest, or this plan can backfire.
• Online purchases: Paying online carries the risk of your financial information being stolen, and you have more protection against online fraud with a credit card. According to the law, you aren’t responsible for any unauthorized credit card charges if your account number is stolen. With a debit card, you may be responsible for them if you don’t report the loss within 60 calendar days of receiving your statement.
• Rewards-related purchases: Many credit cards offer extra rewards for spending in certain categories, such as dining out, travel, or streaming services. If you’ve gotten a credit card to enjoy the perks, don’t miss out; just make sure you include your planned expenses in your budget so you’re not spending more than you can afford. 

Debit card vs. credit card: you don’t have to choose just one

When comparing debit cards vs. credit cards, neither is necessarily better. It all depends on your financial circumstances and the specific purchases you’re making. Many people have both. One common approach is to use a debit card for most day-to-day purchases in order to avoid overspending, but put certain things on credit to get rewards and establish a credit history. Paying your credit card bill on time and making sure you’re not spending more than you pay back can be one way to help increase your credit score. Having both a debit and a credit card in your financial toolbox might help you get the best of both worlds.