Credit Cards vs. Debit Cards: The Differences Can Add Up

When you open your wallet, your credit cards and debit cards probably look the same. And their function is indistinguishable at the cash register. Just swipe, tap, or insert, and off you go. Despite their apparent similarities, these small plastic cards are actually very distinct in how they function once you complete your purchase. Understanding credit card and debit card differences can help you make the right financial decisions for you, your family, and your future.

What are credit cards?

Credit cards represent a line of credit from a financial institution. They have a preset borrowing limit that you can use at any time. Credit cards allow you to borrow a bank’s money to make purchases. You can buy almost anything with a credit card, from plane tickets to a sandwich at your local deli.

On a basic level, a line of credit is a loan: When you borrow the money, you’re required to pay it back, usually with interest. But unlike a loan, where you borrow a certain sum upfront and pay it back in installments, usually over a set period of time, a line of credit is an amount of money you can borrow at any time. When you open a credit card, your credit limit is the maximum amount you can borrow; when you swipe your card, you tap into that line of credit. Essentially, you’re borrowing whatever amount of money you just spent. 

Here’s an example: Let’s say you have a credit card with a $1,000 credit limit. That’s how much the bank has agreed to lend you for that account. You can borrow it all at once, or bit by bit. And once you pay back a chunk of what you’ve borrowed, you can borrow it again. So if you borrow $5, you can still borrow up to $995 more. Once you pay the $5 back, you can borrow the full $1,000 again.

Every time you use the credit card, you borrow money, and you’ll have to pay back what you owe, also known as your balance, on a monthly schedule. Typically, the bank requires a minimum monthly payment, so you can pay back the entire balance every month, or pay only part of your balance. You’ll be charged interest, whatever the annual percentage rate, or APR, is for your credit card, on the amount of your balance you haven’t paid back. Banks set the credit limit and interest rate for each credit card based on the borrower’s credit score and prevailing interest rates, among other factors.

Let’s go back to that example above: Say you use your credit card to buy a $5 sandwich, then use it for a $60 pair of shoes the next day. When the bill comes due, you have a balance of $65 (5 + 60 = 65). If you pay back $40, you’re now carrying a balance of $25 (65 – 40 = 25), and you’ll be charged interest on that balance. That interest is added to your balance. And because you pay interest on your entire balance, you’ll pay interest on that interest over time if you don’t pay off the balance. And contrary to popular belief, carrying a balance won’t help improve your credit score.

What are debit cards?

The credit card and debit card differences might not seem apparent when you’re making a purchase, but they become very clear when you look at your bills and bank statements. Unlike using a credit card to borrow the bank’s money to pay back later, a debit card taps into the money you already have. Debit cards are linked to your checking account; your bank deducts the funds directly from your account when you make a purchase. With a debit card, you can make purchases with money you already have without carrying around cash or a checkbook. Debit cards can offer more security than cash, because they usually require a personal identification number (PIN) to complete in-person transactions. In some situations, however, debit cards can be used without a PIN.

The merchant’s point-of-sale terminal, which is the machine you use to tap, swipe, or insert your card at a cash register, sends an electronic message to your bank to verify that your bank account has the funds necessary to make the purchase. If you do, the transaction is approved, and your bank puts a hold on the funds. The actual transfer of money from your bank to the merchant’s account is usually completed several days later.

Credit cards and debit cards: The difference is in the details 

The key difference between credit and debit cards is where the money comes from. When you use a debit card, you’re using your own money. When you use a credit card, you’re borrowing from a bank. And the loan comes at a price. 

Remember, if you don’t pay your balance in full every month, you must pay interest to the bank. The average APR for credit cards in the third quarter of 2021 was 16.30%. So that $5 sandwich you bought with your credit card will ultimately cost more in the long run because of the interest you’ll pay to the bank, if you don’t pay your bills on time.

And if you don’t make your minimum payment on time, the bank may charge fees, raise your interest rate, report missing payments to credit bureaus, report your debt to a collection agency (which can mean more trouble with credit bureaus and more fees), or take other action. This can harm your credit score, which can have cascading negative effects on your life. 

There are a few other credit card and debit card differences you might want to keep in mind:

• ATMs: Nearly all debit cards allow you to take cash out of your checking account at an ATM; whether or not there’s a fee depends on your bank. Many credit cards also let you get cash at an ATM, but you’re not withdrawing your own money. Instead, you’re getting a cash advance, or borrowing cash against your line of credit, and those can come with high fees and interest rates. 
• Perks: Many credit cards offer rewards for making purchases, such as cash back, airline miles, purchase protections, or points that can be redeemed for gifts. Other perks may include extended warranties on big-ticket purchases and insurance for vacations or car rentals purchased using the card. Most debit cards don’t offer these kinds of rewards, but some cards do have perks.
  

• Fees: Debit cards may have fewer fees associated with them. If you don’t have enough money in your checking account for a purchase, generally your transaction will be declined. However, some banks may also charge overdraft fees for insufficient funds. And If you’ve signed up for overdraft protection, you’re likely to be charged a fee for using it. Credit cards also may have a number of possible fees, including annual fees, and charges for going over your credit limit, as well as late payment fees.
  

Fraud protection: If your card is lost or stolen, federal law limits your liability for unauthorized transactions, but the protection varies between credit cards vs. debit cards. The Fair Credit Billing Act (FCBA) limits your liability to $50 for fraudulent credit card charges. However, with debit cards, the amount you could lose depends on how quickly you report the missing card, based on the Electronic Fund Transfer Act (EFTA).

When to use a credit card vs. debit card

Debit cards can be useful for the day-to-day purchases baked into your monthly budget, and because you’re spending your own money, you may be less likely to accumulate debt with everyday purchases. They may also save you money you would otherwise have spent on credit card interest. But remember, even if your transaction is approved at the register, meaning you have enough in the bank to cover your purchase at that time, the charge might not be processed for a few days. So if you accidentally spend more than you have, the bank might charge overdraft fees.

Credit cards can also have their time and place. Some people use credit cards to take advantage of cash back and other reward incentives, or they put certain purchases on credit if the card offers an extended warranty. If you’re sure you can pay your balance in full before the next due date, you can reap the rewards while avoiding interest. But beware of last-minute expenses that make it impossible to pay in full. Keeping a credit card on hand for emergencies only is also a common strategy, but, again, that can lead to mounting interest. Building an emergency fund and a rainy day fund can help you avoid surprise bills that lead to racking up debt.

Credit card vs. debit card: What’s the right choice?

Many people have both a credit card and a debit card. The differences matter, though. Debit cards can be a great go-to for daily spending, and a little cautious credit card use might net you some perks. Keep in mind, though, that carrying a credit card balance can harm your long-term financial health. 

If you already have credit card debt, you’re not alone, and there are ways to pay it off. By creating a budget and spending only the money you actually have, you can begin to save, tackle your debt, and even start to invest in your future. With a Stash account, you can even use your debit card to start investing with the Stock-Back® Card.1

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