In an effort to help readers better manage their finances, mental_floss has teamed up with personal finance expert and award-winning podcast host Farnoosh Torabi to answer your most pressing credit- and money-related Big Questions. Have a question you’d like to ask? Ask it here, or by tweeting it @mental_floss.
How do you respond when the grocery checker asks how you’d like to pay for your groceries: debit or credit? A debit card and a credit card might look similar and allow you to conveniently settle up without cash, but the two cards function differently—and, more importantly, impact your credit health and spending habits in distinct ways.
When you swipe your debit card, the money is deducted directly from your linked bank account. For security, you may have to enter the PIN associated with your debit card when you use it. If you buy a $500 item with your debit card, and your linked bank account only has $450 in it, the transaction will most likely still go through, but you’ll likely have to pay an overdraft fee to your bank for having insufficient funds.
When you use a credit card, on the other hand, you’re borrowing money from your credit card company to pay for your items. The credit card company gives you a set amount of funds that you may spend, often referred to as your credit limit. If you don’t completely pay off your balance at the end of each billing cycle, you’ll owe your credit card company interest on your balance.
Credit cards have a few big advantages over debit cards. According to Torabi, the best way to establish strong credit is to responsibly use a credit card, as debit cards don’t help you build your credit profile. (Having a solid credit profile is necessary for anyone hoping to borrow money, purchase a car, buy a home, or conduct any of a number of other activities.) Responsible use means consistently paying the full balance of your credit card bill, or at least more than the monthly minimum, on time. Credit utilization is also important; ideally, you should be using no more than 30 percent of the credit you have available. Paying your bills on time and showing that you use credit responsibly will signal to potential lenders that you’re a trustworthy, responsible person to lend money to. “Lacking credit history and a credit profile can lead to challenges down the road when applying for loans and credit cards… even renting an apartment,” explains Torabi. Although debit cards are typically touted as the better option for people who wish to keep a close eye on their spending, some credit card companies offer alerts to keep spending in check.
Credit cards also provide better fraud protection than debit cards, thanks to the Fair Credit Billing Act. If an identity thief uses your credit card number, or your card gets lost or stolen, your maximum liability is $50 for fraudulent purchases. With a debit card, your liability is $50 if you report it within two days, but if you don’t, you could be liable for $500 —even if you report the fraudulent charges within 60 days. Using a credit card rather than a debit card can also make it easier to dispute transactions if you receive damaged or defective items after placing an online order.
Finally, most credit card companies offer incentives to use their credit cards. Although sign-up bonuses, access to credit scores, and 1, 2 or 3 percent cash back on groceries, gas, or travel might not seem like much, these perks can really add up over time.
Before you decide which card to use when, think about your personal spending habits and financial goals. Some people prefer debit cards because they encourage spending within your means. If you only buy items for which you currently have cash, you won’t risk getting into credit card debt. “If you tend to lose track of your spending, then using your debit card better enables you to stick to a budget and avoid overspending,” Torabi advises. “But if you’re interested in establishing a credit profile, you can only use credit for that.”