If you’re new to the world of personal finance, one of the most common questions that money newbies ask is: What’s the difference between a credit card and debit card?
It’s also one of the most important questions for you to get right. There are some pretty significant differences between credit cards and debit cards, and understanding those differences could mean the difference between having a healthy relationship with money and struggling.
Below, we take a look at how debit cards and credit cards work, explore the key differences between them, and offer some advice to help you understand when you should use (or avoid using) each.
You probably already have an idea about what a debit card is, but just in case you don’t: A debit card is a financial product offered by banks and other depository entities that is linked to a checking account. You can make a purchase with a debit card either by swiping it physically at a store or by entering your card number online or by phone. Typically, you will be required to enter a 4-digit PIN to confirm that the card does, in fact, belong to you.
Most debit cards are made out of plastic (though some premium cards can be made out of metal) and contain both a magnetic strip and security chip that are used to make transactions.
When you make a purchase using a debit card, it’s a lot like paying with cash: You can only spend what you have.
So long as you have enough money in your checking account linked to the card, those funds will be deducted from your account and transferred to the retailer. This transfer will often happen instantly, though in some circumstances it could take up to 24 hours or more for your checking account to reflect the new balance.
And if you don’t have enough money in your checking account? That depends on whether or not you’ve opted into overdraft protection through your bank. Overdraft protection means that you have linked a secondary funding source (often a savings account or credit card) to your checking account.
If you have opted into overdraft protection, the transaction will be approved and your bank will transfer the required amount of money from the secondary funding source over to your checking account. They’ll also charge you a fee. According to Bankrate, the average overdraft fee in 2019 was $33.36 per overdraft. If you have not opted into an overdraft protection service through your bank, then your card will simply be declined.
You can also use your debit card to withdraw money as cash from an ATM or from some retailers, though you may be charged a fee if you use an out-of-network ATM. And those fees can be hefty: The average is currently $4.72, according to Bankrate.
A credit card is similar to a debit card in a number of ways. Both are made out of either plastic or metal; both contain a magnetic strip and security chip; both are used to make purchases, either in person or electronically. But that is where the similarities end.
While debit cards are linked to a checking account (and withdraw money from that linked account in order to complete transactions), credit cards are linked to a line of credit—essentially making them a form of loan that you can access as needed.
The chief difference between a debit card and a credit card is this: When you make a purchase with a debit card, you do not need to pay the money back because you are accessing your own money.
When you make a purchase with a credit card, though, you do have to pay it back. If you are unable to pay the balance back in full before your payment period ends (typically a month) then that balance will begin to accrue interest, just like any other loan. And because credit cards are a form of unsecured debt (they are not backed by an asset like a house or a car), the interest charged on a credit card can be particularly high.
With a debit card, you have a natural limit to how much money you can spend: the amount of money that is in your checking account. Credit cards also have a limit, called your credit limit, which is determined by a number of factors including your credit score.
Your credit limit is the maximum amount of money that you can charge to your credit card at any given time. Although you can max out your credit card if you want, doing so can negatively affect your credit score by driving up your credit utilization rate (how much of your available credit is being used), so it is generally not advisable.
Like debit cards, you can sometimes use your credit card to withdraw cash if it is needed. This is called a cash advance. There is typically a limit to how much you can withdraw at one time, and you may be charged a fee by your lender.
Now that you understand the differences between a debit card and credit card, you may be wondering when it makes sense for you to use each. Credit cards and debit cards are two very different financial tools, so it’s important to make sure you know when to use each one. Consider the following advice to ensure you are using the right card at the right time.
If budgeting and managing your own money is new for you, using your debit card for everyday purchases like groceries and other regular expenses can help you stick to your budget and get a feel for what normal spending is like for you.
When it comes to spending, some of us have more self-control than others. If in the past you have experienced issues reining in your spending, a debit card is likely to be the better option for most transactions.
If you are about to buy a home and know you will need to rely on a mortgage to do so, racking up credit card charges could negatively impact your score and impact your ability to be approved or the interest rate you will qualify for. Debit cards do not impact your credit score, and so are likely the better option in these situations.
Signing up for a credit card can be a great way to begin building your credit history and might even help you improve your score. Just be sure that you start small, never spend more than you can afford to pay back, and pay off your balance each month before you are charged interest.
Using a debit card or credit card to make a purchase online opens you up to the risk of identity theft. That being said, credit cards typically come with stronger customer protections that can help you limit your risk. If you are making a purchase online, using a credit card may be the better option.
Many hotels and car rental companies will not accept a debit card for reservations. They require a credit card so that if you were to damage the room or car, they can charge you for those charges.
If you’re making a major purchase like an electronic or an appliance, consider using your credit card. Doing so can offer some valuable benefits, like a free extended warranty for certain purchases. You should check your cardholder’s agreement to know what you may be eligible for.
While the tips outlined above are a great rule of thumb, the key is being practical and smart about how you use credit and debit cards. So long as you stay within your budget and only spend as much as you can afford, they can both be incredibly helpful financial tools.
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