I’ll start out by saying that I don’t use debit cards but I do understand why some people do. It’s linked to your bank account so in theory you can’t spend more money than you have in your account. However, after extensive research, I know now why I’ve always avoided debit cards. The biggest advantage of credit cards over debit cards is the consumer protection they provide.
Debit cards are linked to your bank account. If there’s a problem with a charge to your account you have two business days to notify your bank and your liability is limited to $50. After two days you are liable for up to $500, or perhaps much more. The lender can hold your disputed funds for 10 to 20 days while they investigate the problem. This can be problematic if the funds drained from your account are needed to pay your mortgage, rent, car payment etc. While you wait 10 to 20 days or more to get your funds back, your credit could be ruined.
The situation is the vastly different with credit cards. If there is a problem you have 60 days to notify your bank of a problem and your liability is limited to $50. After 60 days, you are liable for up to $500. While the lender conducts its investigation you may withhold payment of the disputed amount and any related charges. The lender is not allowed to report that underpayment to the credit bureau.
Based on these differences in what situations should you use a debit card or a credit card?
When to use a debit card
1. You are in credit card debt. Clearly, being restricted to only spending the money you actually have is the first step to getting out of credit card debt. Just be certain that you don’t have overdraft protection. This will allow you to overspend and then sock you with fees of $35 and more per transaction as overdraft fees can compound. If you have overdraft protection, contact your bank and opt out. Set up notifications for purchases as alerts for when your balance falls below a certain level.
2. When the only option to pay is with cash or a debit card.
3. When paying cash is cheaper. I haven’t seen this lately but some gas stations charge less if you pay cash. Also in some cities, like Las Vegas, taxis charge a fee for using a credit card.
4. When paying your taxes. Some states and the federal government allow you to pay with a debit or credit card. The fee for paying your taxes with a credit card is usually a percentage of the taxes due. With a debit card it is a flat fee regardless of the amount paid.
5. When you have a separate bank account exclusively for debit card purchases. This account should only contain an amount that you can afford to do without for an extended period of time.
Most of the reasons to pay for certain purchases with a credit card relate to the better protection credit cards offer in cases of unauthorized transactions or disputes. Credit cards should be used for large purchases, in any situations where fraud may be prevalent and in any place where the exact amount of a transaction may not be known when the merchant first requests an authorization for a purchase. In some cases, credit cards offer money-saving benefits that debit cards do not.
Where to use a credit card
1. Restaurants. Your card almost always leaves your sight. This gives unscrupulous employees a chance to skim your card. Also restaurants may put a hold on your debit card in excess of 20 percent over your base bill amount, tying up your money for three days or more. (Skimmers are card reader devices attached to payment terminals that harvest all the data off your card, which criminals use to either clone your card and use it for fraudulent purchases or to empty your bank account).
2. Gas stations. Gas stations are notorious for having skimmers attached to their pumps. Also, gas stations put a hold on your debit card for an amount much greater than your gas charge and the hold can last for three days or more.
3. Taxi cabs. Some people have reported multiple charges for a single taxi ride.
4. Convenience stores and now grocery stores are reporting skimmer incidents.
5. Travel. If you are prepaying for a cruise or a tour package and the company goes bust or flying an obscure international airline that ceases operations, you can get a refund through your credit card. Many credit cards also offer an insurance policy when you purchase airfare on their cards. Some offer other benefits such reimbursement for replacement items if your luggage is lost.
6. Hotels. A couple months ago I stayed at a hotel that put a $400 charge on my credit card just for incidental expenses (the hotel room was free using reward nights). My ending charge was $134.40 but the $400 didn’t come off my card until three days after I returned. This amount would have been put on hold with a debit card.
7. Rental cars. Companies will run a credit check on you when you are paying with a debit card. They do this to combat thieves who use debit cards to rent cars and then steal them. This is known as a hard credit pull and it will negatively impact your credit score.
8. To avoid foreign transaction fees. Many credit cards do not charge foreign transaction fees. All debit cards do. Also, if you are overseas and using your debit card and there is a problem you may spend a significant amount of time and money contacting your bank to straighten it out as well as be stranded without access to cash.
9. When purchasing from an unfamiliar seller. If you purchase something overseas and have it shipped home and it never arrives or arrives broken your bank will intervene.
10. For online purchases. If your merchandise doesn’t show up or is damaged, you can dispute the charge with the credit card company.
11. When buying through PayPal. PayPal has strong protections but people’s debit card accounts have been cleaned out. By linking to your credit card you have the extra protection of your bank.
12. Big-ticket items that require a deposit or advance purchase such as furniture and appliances. Many years ago I ordered a dining room set, which was supposed to be delivered in two weeks. After 30 days I cancelled it but the merchant wouldn’t remove the charge. My credit card intervened on my behalf and got the deposit returned.
13. When warranties matter. That is especially true of electronics, car repairs and appliances. Last year when my hard drive went out on my almost two-year-old laptop, my credit card company paid to replace the hard drive. It offered an extra year of warranty over the manufacturer’s warranty.
14. For automatic monthly payments, such as subscriptions and memberships. A merchant or service provider may continue to charge your debit card even after the service has ended and tie up your funds repeatedly for months.
15. To earn frequent flyer miles, hotel and credit card points and cash back. Depending on your spending level you can strategically use credit cards to earn tens of thousands of miles and points annually that are worth thousands of dollars in free travel. The Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act limited the fees that banks can charge merchants when you use a debit card. As a result, almost no debit cards offer any miles, points or cashback benefits anymore. The few that do are inferior to the benefits offered on credit cards.
16. To build up or improve your credit score. If you’re starting out or got into trouble with spending but now have your financial life under control, debit cards do not improve your credit score. They are the equivalent of checks. To start out get a credit card with a low limit. You can call the bank and ask for a reduced limit if you don’t trust yourself. If you want to buy a car or a home someday and you use debit cards exclusively you will not have a credit score since you have never borrowed any money.
Bonus: Don’t use your debit card at ATM machines. They have long been targeted by skimmers and, unlike a traditional ATM card, which has a daily withdrawal limit, a thief can empty your bank account by stealing your debit card info.
If you have a spending issue, limiting your spending to a debit card can be a good tool to keep yourself or your significant other in check. Just be acutely aware of the risks that debit cards pose. With fraud at an all-time high, use a separate account for debit card purchases. Set up notifications, if you can, through your bank so you receive an email or text for every expenditure over 1 cent and when your balance hits a certain amount (credit card users should do this also). Then check your bank account daily for fraudulent debit charges and know the specific requirements to file a claim with your bank.
If you’ve had trouble with credit cards in the past you may still want to get a card with a low limit and use it carefully to get benefits such as cash back or miles and points for free travel as well as to improve your credit score. Getting your spending under control and using a credit card that you pay off every month will eliminate some of the hassles associated with debit cards but can also be beneficial to you financially if used properly.