Fall 2009

Debit vs. Credit Cards: How They Stack Up
Debit cards, which work like electronic checks, are becoming more widely used as an alternative to credit cards to pay for goods and services. To help you better understand how the two types of cards work and the potential benefits and concerns, we offer this quick guide.

Debit Cards

Consumer Protections

Photo: NCR

Federal law includes protections against debit card errors and the loss or theft of your card, although consumers are required to promptly report a lost debit card or unauthorized transaction. In addition, industry practices may give you added protection.

"To be fully protected under the law, you must submit specific information about unauthorized debit and ATM card transactions within a short time period," stressed Kirk Daniels, an FDIC Supervisory Consumer Affairs Specialist. "That's also why it's important to review your bank statements and report a problem as soon as possible."

Unlike the federal protections for credit cards, which cap your liability for unauthorized charges at $50 (see the credit card section), your liability limit for a debit card depends on the situation and your promptness in reporting the lost card or unauthorized transaction. Specifically, the maximum legal liability is $50 if you notify the bank within two business days after discovering an unauthorized transaction. But if you notify your bank after those first two days, under the law you could lose up to $500, or perhaps much more. Some banks may voluntarily waive all liability for unauthorized transactions if the cardholder took reasonable care to avoid fraud or theft, but consumers must still report errors promptly.

In addition, with transaction errors, banks have up to 10 business days (and in some cases 20 business days) to promptly conduct an investigation after receiving notice from the debit cardholder. If more time is needed, typically because of special circumstances, they can take up to 45 days (and in some cases 90 days) to investigate, but they generally have to credit the consumer’s account for the amount of the alleged error on a "provisional" (temporary) basis pending the outcome of the review.

"Until the bank provides provisional credit, you could temporarily be out of pocket for the amount in dispute," said Richard Foley, an FDIC attorney who specializes in consumer issues. "This would not typically happen with a credit card because consumers can withhold payment of the amount in dispute."

Also, as discussed on the next page, consumers have better federal protections when they purchase faulty goods with credit cards.

Potential Benefits

Convenience and Speed: As with credit cards, debit cards are a way to pay for purchases quickly, without writing checks or having to make sure you are carrying enough cash.

Limiting Your Costs: As long as you don't overdraw your account (see the fees section below), debit cards are a good way to pay for purchases without borrowing money and paying interest. You also may avoid other costs associated with credit cards, such as annual fees.

Cash Back: You can use a debit card when you make a purchase at stores or to withdraw cash from your bank's ATM (generally at no charge). In contrast, most credit cards charge fees and interest for cash advances.

Safety: You won't need to carry large amounts of cash that can be lost or stolen.

Potential Concerns

Fees: Be especially aware of overdraft fees, which can occur if you don't have enough funds in the account when you swipe your debit card but the transaction is still processed.

"You can avoid overdraft fees, which can be costly, by keeping track of your debit card purchases and other transactions and being aware of your balance," warned Joni Creamean, Chief of the FDIC's Consumer Response Center. If overdrafts are a problem for you, consider keeping a little extra in your account, as a cushion. Or, arrange with your bank to link your checking account to a savings account or line of credit. Even though your bank may charge for those services, normally they cost considerably less than overdraft fees.

New restrictions on overdraft fees also are coming. Under Federal Reserve Board rules that will take effect July 1, 2010, you can generally only be charged a fee for ATM and one-time debit card transactions that overdraw your account if you have opted in (agreed) to an overdraft service from your financial institution. Before you can opt in, your bank must provide you a written notice explaining its overdraft services and fees.

Dealing with Problem Transactions Can Be More Difficult: You do not have the right to withhold payment on damaged or defective merchandise, as you do in some instances with credit cards.

Beware of "Holds" on Funds: At the time of purchase, merchants immediately place a temporary hold or "block" on funds for the transaction as protection against fraud, errors or other losses. If the final purchase price is unknown when the card is swiped, the hold will likely be for more than you actually spend. One common situation involves a hotel putting a hold of perhaps as much as $250 or more for each day of an anticipated stay when you use a debit card (or credit card) to check into a room. Another example is when you use your debit card at the gas pump. The hold will be removed when the final transaction is processed, nearly immediately or perhaps a day or two later, but until then, you won't have access to that amount in your account.

Final Words of Wisdom

Debit cards may be especially useful for small and routine purchases, but they are considered less beneficial than credit cards for major purchases or buying items online because of the more limited protections in cases of unauthorized transactions or disputes.

Credit Cards

Consumer Protections

Federal law limits your losses to a maximum of $50 if your credit card is lost or stolen, although industry practices may further limit your losses. You are also protected against billing errors. In addition, federal law may allow you, under certain circumstances, to withhold payment on defective goods until the problem has been corrected. These protections are a big reason why most experts recommend credit cards – not cash, checks or debit cards – when paying for big ticket items or services that you want to know will work as promised.

Also, the Credit Card Accountability Responsibility and Disclosure Act of 2009 is intended to help shield consumers from abusive fees, penalties and interest rate increases. Some provisions of this law took effect August 20, 2009, but most start next year. For example, starting February 22, 2010, a card issuer can't allow you to go over your credit limit and then charge a penalty fee for having done so unless you explicitly agree to this practice in writing. In contrast, most debit card issuers will assess a fee for making a purchase or other transaction that exceeds your account balance.

A Fast, Unsecured Loan: Credit cards enable you to buy goods or services now and – unlike debit cards – pay later. Your payment won't be due for at least 21 days after your monthly credit card bill is mailed or delivered.

Options to Avoid Interest: If your card has an interest-free grace period and you pay the balance off each month, you won't be assessed finance charges.

Building a Good Credit Record: If you're careful about how you manage your credit card, especially by paying your bill on time, your credit score will go up and you may qualify for lower interest rates on loans and credit cards.

Interest Charges: If you don't pay your card balance in full each month or your card doesn't have an interest-free grace period, you will pay interest. This can be costly, especially if you only pay at or near the minimum amount due each month. You also may be subject to interest rate increases. However, as of August 20, 2009, you must be told at least 45 days before any rate increases or other significant change in account terms takes effect. If you don't agree with the new terms, you generally can cancel the card, pay off the balance over time at the original rate and terms, and avoid the new terms.

Overspending: "High credit limits and the ability to earn rewards for using a credit card can make it easy for some people to spend beyond their means," cautioned Janet Kincaid, a Regional Ombudsman at the FDIC. "Don't get caught in the cycle of buying things you don't need or can't afford just to get points for future travel or other rewards. Without even realizing it, you may end up paying more in interest than you're earning in rewards."

Fees: Credit card fees are likely to include those for paying late and going over the credit limit. Some cards also have annual fees.

Credit cards may be especially useful if you want to pay for things when your bank account balance is low or to take advantage of a no-interest grace period.

There's also a different type of credit card, a "charge card," that must be paid in full each month. "A charge card may be a good option for people who are not planning to carry a balance and want to avoid interest charges," said Creamean. "However, if you use your charge card and then have a financial setback, you still need to pay in full each month, whereas with a credit card, you could carry a balance forward until your situation is better."