If you’re like most Australians, you have at least one credit card and one debit card in your wallet.
They may look alike – pieces of plastic with 16 numbers across them, an expiration date and a PIN code; but that’s where the similarity ends.
Actually they're very different beasts.
So how do you know which to choose when you need to swipe or tap the plastic?
In essence debit cards
allow you to spend your
money that you’ve previously deposited with the card provider. They’re like a digitized version of your cheque book, are linked to a bank account and the money is debited (withdrawn) from your account as soon as the transaction occurs.
allow you to borrow money (they’re really a loan) up to a certain limit from the card issuer to purchase items or withdraw cash. This loan is interest-free if the monthly credit card bill is paid on time. Instead of being connected to your bank account, a credit card is connected to the bank or financial institution that issued the card, so when you use a credit card, the issuer pays the merchant and you go into debt to the card issuer.
So which one do you use?
Let’s look a some of the reasons why it makes sense to use one type of card over the other:-
are lines of credit. They’re really a loan with your credit limit set by the card issuer, that you're expected to pay back in full unless you want to be charged interest.
On the other hand with a debit card
you can only spend you money and no more than the amount you have in the account connected to the card.
The biggest advantage of a credit card is the flexibility. You can make purchases without actually having the cash on hand at the time and you have an indefinite amount of time to pay back that money, though you do have to make a minimum payment each month on what you owe.
The big disadvantage of credit cards is that this flexibility is a double-edged sword. The ease of using credit cards, and the lack of pressure to pay off what you owe, makes it very easy to make poor purchasing decisions. Then, when you can’t pay off the card, you pay a hefty amount of interest on that unpaid amount, and over a long period that interest can be incredibly costly.
Most debit cards have few or no fees, while credit cards generally charge annual fees, over-limit fees, late-payment fees and a plethora of other fees and penalties, in addition to monthly interest on the card's outstanding balance.
No interest is charged on your debit card, as you haven’t borrowed any money. On the other hand, with credit cards, interest is charged on the outstanding balance at the end of the month and usually at a very high rate.
Unlike with debit cards, credit card users can reap cash, discounts, travel points and many other perks by using rewards cards. Credit cards can also provide additional warranties or insurance for items purchased rather than paying retailers for extended warranties.
Smart consumers who can pay off their cards in full on time every month can profit handsomely by running their monthly purchases and bills through them. I know I do!
Credit card limits are used by banks in assessing your credit score, but responsible credit card usage and payments can improve your credit rating.
Card Fraud Protection:
Credit cards offer much greater protection if your cards are lost or stolen. As long as you report your loss or theft in a timely manner, your liability is usually capped at $50.
Debit cards monies removed from your bank account as soon as a purchase is made in investigating this may take time, so make sure you report your loss or the fraud promptly.
The Bottom Line
Smart consumers who can control their spending are probably wise to reap the benefits offered by credit cards for the majority of their purchases. On the other hand, cash withdrawals from credit cards are expensive and best made from debit cards.
However, if you’re a less disciplined spender and frugal with fees, a debit card will protect you from borrowing money you can’t afford to spend on items you probably don’t need.
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Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog.