Credit Cards vs Debit Cards: What's the Difference & Which is Better?

When you reach into your wallet to make a purchase, you may find yourself debating whether you want to use your debit card or a credit card.

While they may just seem like pieces of plastic, they have a number of differences. So which option is the best? Choosing to pay with credit or debit depends on your preference. It's important to take your monthly spending habits into consideration and choose the option that's right for you. Here are some pros and cons to consider based on the difference between the two payment methods:

Debit Cards

A debit card is a payment card issued to you by your financial institution that takes money right from your checking account when it is used to make a purchase. Along with being used to make purchases, they can be used to withdraw cash from your account at ATMs. For this we are not discussing prepaid debit cards which have many different qualities from your bank issued card.

Pros:

• No Annual Fees: You don't have to worry about any hidden fees from debit cards, as they are issued for free from your bank or credit union.  
• Interest-Free: Since you are using your own money with a debit card, you don't have to worry about paying any interest on what you spend.  
• Encourages Budgeting: Since you're using the money in your account, you'll typically think more about what you're spending. With a credit card, your line of credit could exceed what you have in your bank account, making it easier to spend money you don't have. Make sure you know how much you have in your account, because if you do spend more than you have, you'll get hit with an overdraft fee.  
• Withdrawing Cash: With your debit card you are able to withdraw cash from your financial institution's ATMs at no charge.

Cons:

• Not Building Credit: While spending and paying your bills responsibly with your credit card leads to a boost in your credit score, spending with your debit card has no effect on your credit score one way or the other.  
• Overdraft Fees: Overdraft fees happen when you don't have enough money in your account to cover purchases made with your debit card. The cost of these vary by bank but they may cost around $35 per transaction. Some banks also charge continuous overdraft fees or daily overdraft fees which are assessed every day the account remains overdrawn. 

Credit Cards

A credit card is a payment card issued by a bank or financial services company that allows cardholders to borrow funds from the issuing company to make a purchase. The cardholder is then responsible to pay back the borrowed money, plus any applicable interest, along with any additional charges that are agreed when applying for the card such as an annual fee.

Pros:

• Build Credit History: Paying your credit card bills on time will help you build up your credit score. Building up your credit can take time, but it's critical to your financial health as it allows you to take out loans to finance a car or even buy a house. The better your score, the lower the interest rate you are likely to receive.
• Better Rewards: While there are checking accounts that offer some cash back incentives for spending with your debit card, credit cards typically offer much more lucrative and diverse rewards. When you use your credit card, you almost always earn points on all purchases. Depending on the card you have, you can earn more points based on where you're shopping. These points can then be redeemed in the form of cash back, travel miles, and more. You can select a card that fits your lifestyle to help you maximize the rewards you get.

Cons:

• High Interest Rates: If you are not paying your balance in full every month, you can incur high interest rates. This will lead to paying much more in the long term.
• Can Lead to Bad Spending Habits: Overspending with a credit card can also contribute to increased debt. Don't treat your credit card like a gift card and swipe irresponsibly. Even if you charge just a little too much on your card one month and then vow to pay it off the next, the balance will still increase at a high interest rate as mentioned above. Since the interest will be added each month, the debt continues to grow. If you are not paying your bill in full every month, the debt you'll incur will completely offset any potential pros of using a credit card.
• High Utilization Ratio Impacts Your Credit: Your utilization ratio is the sum of all your balances, divided by the sum of your cards' credit limits. If you allow your utilization ration to get too high, it will negatively impact your credit score. Generally, it is recommended to keep your utilization rate below 30%.
• Annual Fees: Some credit cards may have an annual fee in addition to interest on debt. Before applying for a card, make sure you're aware of whether or not the card has an annual fee, and if so, decide if its rewards outweigh the cost.  
• Strict Approval Requirements: Often to be approved for the card with the best rewards, there is a high barrier to entry. For these cards you'll often need a credit score above 700.

Bottom Line

Whatever form of payment you choose, there is a time and place for both a debit and credit card. Debit cards are generally safer option while credit cards offer a number of enticing benefits but also have a number of negative consequences if not used responsibly. So, the next time you swipe at the checkout line, consider the choice that aligns with your financials goals.