Credit Cards vs. Debit Cards – What is the Difference and How Do They Work?
What is the difference between a debit card and a credit card?
When you use a debit card, money is withdrawn from your checking account in real time. With a credit card, you are borrowing money from the bank, with an agreement that you will pay a portion of it back each month.
The Debit Card
Debit cards are very simple. When you swipe or insert your debit card, funds are immediately withdrawn from your checking account and sent to the merchant. The biggest advantage of the debit card is you never have to worry about paying interest on a purchase.
Another great feature of the debit card is the funds available to you are equal to the current balance in your checking account. Unlike a credit card, you cannot go into debt using a debit card. However, it is important to keep in mind you can still overdraft your account—meaning you spend more money than is available in your account, making your account balance negative. In this case you can incur overdraft fees and must repay the negative amount to bring your account into good standing.
Debit cards are extremely simple to get—when you open a checking account, you will have the option to get a debit card for that account. Opening a checking account and obtaining a debit card does not cause a hard pull on your credit report, so your credit will not be affected.
The Credit Card
Credit cards are also a very useful financial tool, but unlike the debit card, there are inherent risks with using credit cards.
When applying for a credit card, you are essentially applying for a line of credit with the bank. Based on your credit score and credit history, the bank will issue a credit limit.
Whenever you make a purchase using your credit card, the bank pays the merchant and then deducts the amount charged from your credit limit. When you receive your monthly statement, all the purchases you made during the month will be totaled, and that amount is your total balance due. You can choose to pay the balance in full, a portion of your balance, or the minimum monthly payment—a percentage of your total balance. If you pay the balance in full, you will not incur any interest charges. However, if you do not pay the total balance, you will incur interest on the unpaid portion of your balance.
For example, let us assume you get approved for a $5,000 credit limit on your new credit card. Every purchase you make will be deducted from the $5,000. If you spent $1,500 on your credit card in the month, your available credit would be $3,500 and the total balance due would be $1,500.
If you can pay off the $1,500 in full, you will not incur interest. However, if you cannot, the interest will be tacked on the balance and will accrue each month the balance is not paid in full.
Are credit cards unsecured debt?
Unless you are applying for a secured credit card, credit cards are a form of unsecured debt. This simply means there is no collateral backing the debt and lenders issue the funds to merchants with only the promise from the borrower to repay the debt. This increases the risk for the lender and therefore also increases the interest rate you will pay.
The average interest rate for a new credit card in 2020 is 18% and for a student credit card is just over 21%.
Why use a credit card over a debit card?
When used properly, credit cards can improve your financial situation and they often have additional perks a debit card will not offer.
When you apply for a mortgage loan, auto loan, personal loan, home equity line of credit (HELOC) or any other type of loan, your credit report and credit history will determine your creditworthiness. This simply gives lenders a baseline to assess how much risk you are to the lender.
Using a credit card and paying the balance off each month will create a positive credit history and improve your credit score for future loans. However, the opposite is also true — if you miss a few payments and carry a balance on your credit card, your score and credit report will be negatively affected.
Credit cards often offer perks such as travel rewards, cash back, bonus sign-up offers, and loyalty rewards. The key is to use a credit card wisely to improve your credit score and take advantage of the benefits that come along with a credit card.
What should I look for in a credit card?
Not all credit cards are the same and you should determine which one is best for you based on the reason you are applying for the credit card.
Credit cards based on your spending habits
There are many credit cards that give out benefits and bonuses for purchases with different types of merchants. One card may offer higher rates of cash back on groceries where another card may offer more rewards points for booking travel.
A good rule of thumb is to determine where you spend most of your money and then find a card that rewards you for that category of spending in your life.
Credit cards based on your rewards preference
Not all rewards are the same and different cards will come with different rewards programs. If you travel often, then a credit card that offers travel rewards might be best for you. However, if you would rather get cash back, gift cards, or other credit card rewards, you can apply for a card that allows you to choose the type of rewards you get in return for your purchases.
One important factor that should not go overlooked is determining the annual fees. There are credit cards that do not have any annual fees and there are others that can range anywhere from $40 per year to over $1,000 per year. Before you apply, make sure you understand the annual fee structure.
Best advice for using a credit card wisely in college?
Your goal as a college student with a credit card is not to earn rewards, but to build your credit. A good credit score a few years from now will pay much higher dividends than any travel rewards or cash back program.
For example, a credit score of 600 versus 700 could mean tens of thousands of dollars in added interest based on a higher interest rate due to the lower credit score.
Using a credit card as a college student
Start off using your credit card for your needs instead of your wants. Are there bills you know you are going to have to pay no matter what? Think about your supplies for school, internet, groceries, or any other things you know you are going to need. Once you determine the needs as a college student, you can pay those needs with your credit card and then pay your balance off.
But, if you are still too tempted to use the card for the wants in life, then try this: place your credit card in a cup of water and stick it in the freezer. Before you can use your card, the ice must melt, which keeps you from making the pain-free impulse purchase on your credit card.
What information do I need to have ready for a credit card application?
The good news you do not need much to apply for a credit card.
You can apply online, by phone or at any branch with your photo ID, your social security information and proof of income, like a paystub.
Why do I also need to have a checking account?
If you have a credit card, you will need a checking account to make your payments each month. If you have a mortgage or rent, you will need to write a check or make an ACH payment each month. Even standard bills, like your cell phone or electrical payment, usually require that you pay from a checking account.
Also, when you earn a paycheck, you will need somewhere to safely deposit your money. Although savings accounts can store money as well, checking accounts allow you the flexibility to withdraw money at any time from the account without incurring a fee or penalty.
What should I look for in a checking account?
Checking accounts are not all the same and it is important you understand the requirements and structure of a checking account before you open one.
Some important things to look for when with a checking account are the monthly fees (if any), the minimum balance requirements, how many transactions per month, direct deposit, ATM access and fees, and online or mobile availability.
Debit cards are always going to be the safer route when it comes to your financial transactions. You will never have to worry about paying interest, going into debt, or getting into financial trouble with a debit card. Click here to learn more about OneAZ Checking and open an account.
Unlike debit cards, credit cards come with a greater risk. However, when used properly they also bring a much higher reward in the form of cash back, points, travel funds or an improved credit score for future loans. Click here to see OneAZ’s full suite of Visa® credit cards and apply today.
Chris “Peach” Petrie is the founder of Money Peach. Money Peach partnered with OneAZ to provide free financial education to members across the state. To learn more about OneAZ’s partnership with Money Peach, click here.
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APR = Annual Percentage Rate