“How will you be paying today, credit or debit?” is probably the most asked question at the point of sale. “Did you find everything you need today?” is probably a close second. Many times you might be wondering, “Whats the difference between debit card and credit cards?” Why should someone choose one over the other.
The debit versus credit question speaks to the prevalence of plastic payments in our society. And while debit and credit cards appear identical physically, there are some key differences between the two. Moreover, each one has its pros and cons.
What is the main difference between a debit card vs. credit card? Debit cards are connected to a checking account, while credit cards are connected to a credit line. Most consumers know that, but there are some other key differences and implications.
We’ll go into these in terms of how debit and credit cards are different. If you’re a business owner and wondering which one is better (in terms of payment) we’ll cover that too, toward the end of the article.
Whatever Happened to Cash?
Some readers may be wondering: isn’t cash better than credit cards or debit cards? Indeed, around 14% of consumers pay for all their purchases with cash. There are lots of interesting stats around the habits of these consumers, in comparison to plastic payments.
The average cash transaction is about $22, while the average credit card transaction may be over $91. Understandably, debit card purchases fall more toward the cash end of the spectrum, at an average of $36 per purchase. It’s easy to spend more when you can pay later (and more on that, later).
A few more interesting stats will help us zone in on cash transactions. 54% of consumers under the age of 50 don’t care about carrying cash, while a much higher 71% of consumers over the age of 50 do care about carrying cash. But wait…there’s more. Additional nuanced insights are related to household income, and not just age.
About 59% of households making more than $100,000 make no purchases in cash. None. And around 45% of households making between $49,000 and $100,000 make no purchases in cash.
On the flip side, about 20% of households making between $30,000 and $50,000 make most or all of their purchases in cash. And of households making under $30,000, the same is true for around 30%.
Why Do Some Consumers Prefer Cash?
Over the last few years, consumers in every age group have been shifting more and more toward cashless payments. However, statistics are still presenting an informative trend. Older consumers and households with less income tend to use cash more often. And as other statistics have shown us, cash tends to be on the lower end of transaction size.
Whether or not there is some overlap between these demographics (older consumers and less wealthy) needs further research. But one could read into this a prevalence of more conservative spending habits. In the case of low household incomes, that conservatism is a necessity, whereas in older consumers (who have lived through multiple recessions) it may be an ingrained habit.
Either way, there’s no arguing that cash is fairly easy to keep track of. Some people are paid in cash, such as the breadwinners of the 4.5% unbanked households in America (meaning, they have no bank account). And some consumers just prefer to use cash. Cash holders can only spend what’s in their wallets, which may lead to more careful purchasing.
Cash is Inconvenient and Easy to Lose
But cash also presents some significant inconveniences. 95.5% of households are banked, and most employees are paid via direct deposit or paper check—not cash.
It is actually inconvenient for most Americans to take cash out of the bank with a debit card. Cash is also inconvenient to carry around. It’s bulky, and it can easily be lost or stolen.
This is why an overwhelming majority of consumers prefer to make their purchases with a plastic card. Around 44% of polled American consumers use a debit card for everyday purchases, while 34% use a credit card.
Many of the consumers who primarily use debit cards (71%) are or have been in credit card debt. And about 24% of these polled consumers believe that using a debit card improves their credit score (it doesn’t).
While the last two stats are interesting finds we’ll explore in more detail later, we’ll first turn to the debit versus credit card breakdown. Consumers face a choice: should I use a debit or credit card to pay for my purchases? What’s better, a debit card or a credit card? And what are the differences between debit and credit cards?
What Are Debit Cards and How Do They Work?
First the debit card. A debit card (as mentioned) links to your checking account. A debit card is used for spending. But it’s also a sort of plastic key for accessing your funds at the bank or an ATM. For these reasons, a debit card is also be referred to as an ATM card.
However, technically speaking, an ATM card is only for withdrawing or depositing cash. In any case, most debit cards these days function as ATM cards as well.
The main thing consumers use debit cards for is making purchases. When they purchase a good or service, the merchant uses a payment processor to collect information from the debit card. This information then passes between the customer’s bank, the payment processor, and the merchant’s acquiring bank.
If there is no likelihood of fraud and there are sufficient funds in the customer’s account, they recieve a debit for the amount they owe. The the merchant receives a credited. Within 24-48 hours, the funds settle and the transaction is complete.
Take note that this overview of debit card payment is a summary, and there are more details to the transaction. However, to understand how they differ from credit cards, this description covers all the bases.
What are Credit Cards and How Do They Work?
And now on to the cousins of debit cards: credit cards. Credit cards appear the same. 16 digits (15 for American Express), often with the numbers grouped in fours.
An expiration date by month and year. A three-digit CVV or security code. A space for a signature. And (at least until they disappear by 2030) a magnetic strip on the back.
But the payment process of a credit card is much different. That’s because the credit card and bank account are not linked. Rather, it represents a credit line extended by the issuing bank to the cardholder. The issuing bank is the financial institution from which the consumer gets the card.
When they make a purchase, this amount is debited from their credit line, and credited to the merchant. The remaining amount of credit is the new amount of credit available to that consumer until they pay the balance in full.
An example: let’s say a consumer has a credit card from CHASE with a $5,000 credit line. They make a $400 purchase. Their available credit is now $4,600.
If they make no other purchases that month, they’ll get a bill from CHASE for $400. The merchant they shopped at has already received payment—and CHASE fronted the cash. Now the consumer owes CHASE back.
An Interesting Thing About Credit Cards…
Of course, they don’t have to pay the balance in full. They can make the minimum payment, which will probably be $25. However, (unless they have some sort of 0% interest promo on their card) the remaining amount will be subject to interest charges.
Let’s say they pay double the minimum payment. The $350 they still owe CHASE will be charged with interest. For the sake of simplicity, let’s say that’s 20% annually (the average rate is 24.4% right now). That’s going to be about $6 extra the first month, and then less and less after that until it’s paid off.
However, most consumers continue to use their credit cards, building the balance higher and higher, and paying more and more interest.
The average credit card balance varies by state, but nationally it’s around $5,525. Moreover, around 6% of consumers have more than $10,000 in credit card debt. Interest applied to these balances can become burdensome. For instance, a 20% interest rate applied to $5,000 in credit card debt becomes $1,000 annually or an additional $83 per month.
You might be wondering: what’s so convenient about buying now and paying later if it costs so much money in the long run? We’ll get to that when we talk about credit cards vs debit cards pros and cons. But first, let’s wrap up our overview of credit card payments.
Credit Card Issuers Versus Card Networks
Like debit cards, a payment processor also collects credit card information. This info is then bounced to the cardholder’s bank for a fraud and credit check. If that all checks out (pun intended), the rest of the transaction can be completed.
We should mention that typically, one of four parties (the card networks) – Visa, Mastercard, American Express, and Discover – is responsible for ferrying the information of both debit and credit cards around the digital sphere.
Sometimes when a debit card is used (particularly with a PIN number), the system routes the information over an alternate network. However, Visa or Mastercard usually own most of these networks, so we won’t delve into splitting hairs.
American Express and Discover are card networks and credit card issuers that also provide their own cards. You might know this from their advertising but perhaps have not considered the subtlety that the card network is synonymous with the card itself.
This sets Amex and Discover apart from Visa and Mastercard. Banks and credit unions like CHASE, Bank of America, Wells Fargo, Citicorp, or your local or regional bank or credit union issue the overwhelming majority of Visa and Mastercard cards, not the card network themselves.
There are hundreds of credit cards out there, some of which offer perks such as earning rewards (more on that later). The Visa or Mastercard stamp on the card is just a sign that this particular card will send payment info through that network.
How to Get a Debit Card or Credit Card
It’s easy to get a debit card. All you need is a bank account. And if you have a Social Security Number (or Resident Alien ID) and a few dollars to deposit, you can get a bank account with most banks. Keep in mind you’ll have to keep depositing money into the account, and usually, if it’s not at least $500 per month, you’ll owe a convenience fee.
Credit cards are more difficult to get because you need excellent, good, or at least decent credit to get one. Credit cards will require the cardholder to fill out an application and input information like their name, social security number, employment, and income.
The bank will check this application out and read over your credit history, as recorded by the robed immortals in the subterranean chasms of Equifax, Transunion, and Experian. About 25% of Americans cannot get a credit card, due to their poor credit. There are ways of improving that, but they often take time. One way is getting a secured credit card. This is where the cardholder puts down a deposit that matches the credit line as a security.
You might be wondering: what about those debit cards with money? Or rather, pre-loaded debit cards? Those are technically gift cards, and they are sold by the four major card networks. These are not linked to a bank account, and they are not credit cards.
The money is “on” the card so to speak, which presents concerns about theft and/or loss. For these reasons, they’re not typically a good choice for regular use. But they can make great gifts.
Should I Get A Debit Or Credit Card?
That’s a brief overview of how credit and debit cards differ at the point of sale. To consumers, the difference is not noticeable at the point of sale.
But it’s noticeable in terms of impact on their bank account. Debit cards mean you are paying now. Credit cards mean you can pay later…but pay interest in return.
So now on to the question that has you salivating: Beef Burgundy with an aromatic infusion of local herbs and subtle notes of Bordeaux’s finest wine? Or a plate of escargot in butter, with savory undertones of garlic and parsley? Just kidding. The question is whether debit or credit is better for you.
Credit Cards Help Build Credit
One of the benefits of using credit cards is that they help build credit, while debit cards do not (contrary to the belief of the 24% of polled consumers cited above). Remember that credit cards are essentially a loan from the bank that issues them.
Credit cards are referred to as rotating debt because as it’s paid up, the credit line is restored for usage. This is different from debt like a mortgage or car loan, where the loan is extended one time and paid off on a timetable.
To determine someone’s creditworthiness, credit analysts need a little history to work with. If you are a potential borrower, they’ll want to know a few things.
Are you ever late on your payments? How much do you pay…just the bare minimum, or above and beyond? How quickly do you repay your debts? How much debt do you take on?
Credit cards are an excellent way to build credit and give credit analysts the answers to some of these questions. It’s hard to get a car loan and definitely hard to get a mortgage without a credit history. For most consumers, credit cards are a necessary tool for proving that you can take on bigger loans like the one you’ll need to buy a home.
Does Having a Debit Card Build Credit?
No, it does not. Debit cards have nothing to do with borrowing money. In fact, if you don’t have enough money in your bank account, a debit card won’t even work at the point of sale.
Rewards Credit Cards Offer Cash Back and Points
Credit cards also offer rewards, which debit cards do not (to be fair, very few do). The two most common formulas used are cash back and points. The card issuer multiplies the cardholder’s spending by a fixed percentage to offer cashback rewards. Oftentimes there are cash back categories, such as 3% back for gas and groceries, 2% at restaurants, and 1% for everything else.
Credit card issuers usually offer points based on a per-dollar basis. Sometimes awarding additional points for specific types of purchases, such as 1 point per dollar but 2 points per dollar on airfare. Either way, credit card holders can see some significant advantages from this cash back or these points.
Why Are Credit Cards More Convenient Than Debit Cards?
Credit cards are not necessarily more convenient at the point of sale, per se. But credit cards can also do some other cool things that debit cards cannot do.
Credit cards can offer balance transfers. This form of debt consolidation can be used to pay down any type of loan with an account number, including other credit cards. It works like this: your credit card will pay off the other lender (or a portion of the loan).
You will now owe the credit card that money, but the money will often be at a 0% interest rate for 12, 18, or 21 months. Balance transfers are useful for paying off your debt faster, since interest is cut out of the picture.
Hidden Perks and Hidden Fees
Credit cards also have some hidden perks. Certain cards like American Express grant you access to travel lounges at the airport, or discounts at hotels. Your credit card company may provide mobile phone insurance or travel insurance.
Certain card companies (like Visa) can facilitate roadside assistance. Others can give you special privileges when booking entertainment and sporting events.
If you want a full list of side perks, consult the brochure sent with your credit card, or call the card network. Most consumers find it surprising to learn about all the hidden benefits of their credit card, which have nothing to do with the convenience of buying now and paying later.
However, sometimes these perks come with fees. Most consumer-facing credit cards offered by large banks do not have fees, but those that offer specialized rewards or lots of side perks may charge an annual fee. By contrast, there is typically no fee for a debit card, even if the underlying account has a maintenance fee.
Are Debit Cards Fraud Protected?
Both credit and debit cards have multiple layers of fraud protection, facilitated by all the players in the payment landscape: your bank, the card networks, and the payment processor. However, debit cards have one disadvantage in comparison to credit cards: they are linked right to your bank account.
If a criminal gets a hold of your actual debit card or your credit card information, they can use that information to make purchases right from your checking account. Although there is a process for recovering the stolen or misappropriated funds, in the meantime, you’re out of cash.
By contrast, a credit card is not linked to your bank account. If someone uses the credit card, you can file a dispute and still have your cash while the dispute unfolds. For these reasons, a credit card may arguably be more safe for consumers, because it has that extra buffer.
Credit Cards May Put You Into Debt
Credit cards may be more dangerous for certain consumers. There is no hiding the fact that banks want to encourage consumer spending on credit cards. They will use aggressive colors (red) or sleek, gloss appearances to facilitate spending. Points and cashback may also encourage lots of swiping.
And consumers have shown a response to these tactics, perhaps aided by the natural ease of using credit to live beyond their means. Recall that the average credit card purchase is 8 to 9 times higher than cash purchases, and about 4 or 5 times higher than debit card purchases.
This is why about 35% of Americans carry credit card debt from month-to-month. Interestingly, this percentage increases significantly from a college degree to those having only a high school diploma, or no high school diploma. In other words, debt may be linked to poor spending habits, which in term may stem from a lack of financial experience.
For some consumers, credit cards don’t change spending behaviors much. They just give the cardholder points for the same thing they’d do anyway. For other consumers, credit cards trick them into living beyond their means.
Debit cards, by contrast, encourage spending within your means. For some consumers, this can outweigh the pros of points and cash back. For some consumers who can’t really afford to live beyond their means, credit card usage eventually leads to bankruptcy.
What’s Better for Businesses to Accept?
Debit card vs credit card merchant fees are the main consideration for business owners. Card networks each have their own fees, but generally, they are around 2%. Your merchant bank and payment processor will also have fees. These are all wrapped up in the merchant discount rate.
Debit cards end up being a bit less expensive. Especially with the collection of PINs. Some payment processors will obscure this fact by charging you flat rate pricing. But the reality is that every type of transaction (swipe, chip, tap) and every type of card (Visa, Mastercard, etc.) have different prices.
At the end of the day, you cannot really force your customers only to use debit or only use credit cards. In some states, there are legal restrictions around this. And practically speaking, it makes for a bad customer experience. You should be prepared to accept all types of plastic.
Work With a Payment Processor to Collect Debit and Credit
What you can do is work with a payment processor who will offer you transparent pricing—something like an interchange plus payment model. In this type of model, you will get different interchange fees for credit versus debit, so when customers do use debit, you can save money.
On the other hand, remember that credit cards lead to bigger purchases. This is one of the reasons that merchants like to display signage in their stores about what credit cards they accept. While the fees might be higher, you’ll get more sales and bigger sales.
But either way, credit or debit, plastic payments are convenient for most consumers. And to reap the rewards of this convenience, you need to work with a payment processor who can help you collect plastic payments.
A good payment processor will implement security and anti-fraud measures to ensure that you do not face disputes and chargebacks. As you can see, there are a lot of concerns that go into collecting credit and debit card payments.
If you’re a merchant and have any additional questions about how to collect credit and debit payments, give us a call or fill out the form below.