Are you confused about when to use your debit and when to use your credit card? Don’t worry! You are not the only one. Discover the differences between debit cards and credit cards and which one you should use in different circumstances. Whether you’re doing your weekly shop, paying for car repairs, paying for a holiday or buying some flip flops online it might pay to make sure you’re using the right card…
- Debit cards are generally a safer option, as you’re spending money that you already have in your account
- If you need to make a purchase on credit, credit cards are usually a cheaper option
You might use credit cards and debit cards in similar ways, however, they serve different purposes and are each more useful than the other in certain circumstances. While you can use them both to make the same types of payments, they aren’t entirely interchangeable. In this chapter, Cashfloat explores the differences between debit cards and credit cards and explains how to use them both safely and correctly.
Should I Use a Debit Card or a Credit Card?
Both debit and credit cards help you pay for things, but generally one of them uses your own money, while the other uses borrowed money. When you buy something on your credit card, you haven’t technically paid for it. You have only borrowed money from the credit card company to make the purchase, and at some point, you will have to pay them back. Of course, a shop isn’t going to come chasing after you for the money. But your credit card provider will. Using a credit card is a great way to improve your credit score and they come with other benefits as well. However, it’s important to know how to use it in the right way and when it’s better to use a debit card.
Debit cards are linked to your current account. Every time you make a payment with your debit card, the corresponding amount is charged (debited) to your account. Normally, debit cards are not used for credit and people keep enough funds in their account to cover their purchases. However, current accounts can provide credit in the form of an overdraft and debit cards can be used to access it. Unlike credit cards, current account overdrafts are generally only designed for emergency borrowing, rather than as a longer term borrowing arrangement.
Credit cards are effectively loan cards. When you spend money on a credit card, your credit card provider lends you the money, so that you can spend it. You then have to pay this back. If you do not pay the money back before a certain date, then you will be charged interest for borrowing it. As well as providing access to credit, credit cards can come with other features, such as rewards or an opportunity to build your credit rating. The borrowing conditions (interest rates mainly) are generally more favourable with credit cards than they are with current account overdrafts. For in depth information on how credit cards work, go to Chapter 6 of this guide.
How Debit Cards Work
Anyone who has a current account (a normal personal bank account) will have a debit card which allows them quick access to the funds in their account. You can use a debit card at cash machines, at your bank to pay bills and to deposit cheques, to make purchases in shops or with other merchants, or to pay for things online.
The UK has used ’chip and PIN’ cards for fifteen years now, making purchases in shops very straightforward. These devices negate the need for a signature and mean you only need your card and your PIN to make a purchase. The introduction of chip and PIN was a revolutionary move, which made purchasing with a card simpler than it had been previously. However, more recently, contactless debit cards were introduced and now you can just tap your card to make purchases of up to £45.
Debit cards are for making payments with your current account. Your debit card is linked to your current account and every time you make a purchase with it, that amount of money is taken out of your account.
Virtually all debit cards in the UK use either Mastercard or Visa to process payments. This makes them suitable for use all over the world, as these are the most widely accepted payment systems, globally. If you are paying for goods or withdrawing money while abroad your account will be subject to charges and you may find it cheaper to use a prepaid travel card.
Your Current Account
When you pay with your debit card, you’re always using your own money unless you go into your overdraft. Any payments that you make, which don’t use your overdraft, are just taken out of the money that you have in your account. There are usually no fees for doing this and it is simply a case of the purchase you make being taken out of your account. Some payments can take a few days to process, meaning that they don’t show up on your account immediately.
If you have an overdraft facility arranged with your bank account and you spend more money than you have deposited in your account, then you can borrow money from your bank using your overdraft. In some circumstances it will not cost you anything to do this and in some circumstances it will. You can check the terms and conditions of your bank account to see if using your overdraft will cost you money.
Some overdrafts have an interest free limit. This means that you can borrow up to a certain amount without paying anything to do so. Usually after a certain amount, interest will be charged. This means that the longer you borrow money for, the more it will cost you. Some accounts have no interest free limit and any use of an overdraft will incur an interest charge.
Banks will always allow you to borrow up to the limit of your arranged overdraft facility. If you attempt to borrow over your limit, they may not allow you to do so. Previously banks would charge high fees to customers who exceeded their arranged overdraft limit and also charge them extra interest. However, new rules have been introduced and it is now much more difficult for them to charge fees for this and they also cannot increase interest rates. If your bank allows you to exceed your arranged overdraft limit it will now cost a similar amount to money that you borrow within your overdraft limit. Remember that you will still owe money though.
When to Use a Debit Card
Debit cards, generally, allow you to access funds that you already have. Spending money that you have is much safer than borrowing money and it is usually much safer to use a debit card. You will be avoiding the risk of getting into debt. If you have the funds available in your current account and there is no additional benefit to using a credit card, such as to benefit from rewards or to improve your credit rating, then it is always much better to use a debit card.
However, if you do not have the funds available in your current account for a purchase that you need to make or if it will leave you with very little money, you will need to consider your borrowing options. You can either borrow with your overdraft or with your credit card if you have one. Using an overdraft to borrow money is often a poor choice, compared to a credit card. The interest rates charged for current account overdrafts are often higher than credit cards (many overdrafts are charged at 39.9% APR). This makes it cheaper to borrow money with a credit card.
If you do need to borrow money and you have a credit card available, then it is normally better to borrow from your credit card. That said, it is always a good idea to check how much it will cost you to borrow by each method and to make sure that you are making the right choice. For example, you may have an interest free amount in your overdraft, which will make it cheaper to actually borrow with your overdraft if you are going to spend within it. The key point is that it is usually better to borrow with a credit card, rather than with an overdraft.
One point to note about when to use a debit card instead of a credit card is that when it comes to cash withdrawals, in most circumstances, it is better to use a debit card. Credit cards usually charge fees for cash withdrawals and these can be quite expensive. Often, even if it means going overdrawn, it is better to use a debit card to make cash withdrawals. As is always the case, the rules vary for different debit and credit cards, so it’s best to check the terms and conditions of your cards to make sure you are making the cheapest choice for withdrawing cash.
As well as being useful for borrowing money, credit cards offer certain benefits which come with using them. In the next section, we will explain how spending on a credit card to access rewards and purchase protection or to build your credit rating might be a good idea, even if you do have the necessary funds available in your current account.
Try Not to Borrow in the First Place
Proper budgeting can help to prevent you from needing to borrow money in the first place. As well as keeping enough money to pay for daily expenses, it is a good idea to build up an emergency fund. These savings can help you out if disaster strikes and you need, for example, to repair your car or pay a vet’s bill when you weren’t expecting. Rather than needing to use your overdraft or a credit card you can use your emergency fund instead.
Using Prepaid Cards
Have a look at Chapter 14 of this guide for an in-depth explanation of how prepaid cards work. With a prepaid card, you have to put money onto it before you spend it. There is no overdraft facility or any form of credit available. If you’re trying to budget your money, these can be really useful as you will be completely unable to overspend.
Prepaid cards don’t require a credit check and some can even be used to build a credit rating. As well as being good for those on a budget, they’re excellent to give to teenagers and businesses often use them for their employees. One catch with prepaid cards is that there are often fees for taking one out, monthly membership fees and fees, sometimes, for making payments with them.
How Credit Cards Work
The best way to think of a credit card is as a loan card. Every time that you make a payment with a credit card, you are borrowing money from your credit card provider. If you are able to pay the money back before a certain date you will not be charged anything for borrowing it. However, if you do not pay it back before that date, then you will be charged interest for borrowing it. The longer that you borrow money, the more you will have to pay in total. For in depth information on how credit cards work, go to Chapter 6 of this guide.
The terms and conditions are different for different credit cards and it is important, if you take one out, to make sure you know exactly how much it will cost you to borrow money with it. Some credit cards come with interest free periods, where it will cost you nothing to borrow money, making them the best way to borrow money if you are able to pay it back before the interest free period ends. On top of interest charges there can be other charges associated with credit cards, such as monthly membership fees.
As well as providing a means to borrow money, credit cards can come with other benefits, such as rewards schemes for spending with them and section 75 protection of purchases between £100 and £30,000. Section 75 of the Consumer Credit Act makes credit card providers jointly liable for purchases of this value, meaning that you can ask your credit card provider to give you a refund if you have a problem with your purchase. As well as the previous benefits we’ve mentioned, credit cards also give people a chance to build their credit rating.
When to Use a Credit Card
As we said earlier, borrowing money is a risk. If you are unsure about whether you will be able to pay back money that you borrow with a credit card, it is safer not to use one. However, if you do need to borrow money and you’re able to do it safely, then credit cards can be useful. As well as being a good way to borrow money, using them can be helpful in other ways.
The first point is that when it comes to borrowing money, credit cards usually offer a cheaper way to do it than debit cards. As we said earlier, the cost of borrowing from most current account overdrafts is usually higher than borrowing from a credit card. This is because APR rates are generally lower for credit card borrowing. Also, if you are able to pay the money back before a certain date, then it will usually not cost anything. If you do need to borrow money then, usually, doing so with your credit card is the best option. That said, it’s a good idea to check the terms and conditions of both your credit card and your current account overdraft to make sure that you’re making the best choice.
As well as offering a cheaper way to borrow money, using a credit card can be helpful in other ways. People benefit from using them to take advantage of certain features that they have, even when they have the funds to make a purchase available in their current account, as we will explain below.
- Purchase protection
- Building your Credit Rating
Credit cards offer section 75 protection, under the Consumer Credit Act. Your credit card provider is liable for purchases you make with your credit card for goods between the value of £100 and £30,000. That counts for the whole value of a purchase, even if you actually only pay for a small part of it with your credit card. This protection can be very useful and gives you an alternative avenue to go down to claim a refund for a purchase that you end up having a problem with. This is particularly useful when you make a purchase from a company which subsequently goes bankrupt, leaving you without what you purchased and no way to reclaim your money from them.
What many people do is pay the deposit (or a similar small amount) for a valuable item using their credit card. Because they have partly purchased the item with their credit card, the whole value of the item is protected by their credit card provider. While the whole value is protected, having only paid a small amount with their credit card, the person has not borrowed a large amount of money.
Many credit cards come with rewards for using them. These can be things like cashback, points which can be used to make purchases or air miles, which can be used to get reduced rate flights. If you are able to spend sensibly with a credit card and to ensure that the cost of borrowing does not outweigh the value of rewards given, then the rewards that credit cards give can be useful. It should be noted, however, that rewards are not always as attractive as they seem at first and the cost of borrowing or paying membership fees for a card that comes with rewards can often outweigh the value of the rewards.
Credit cards can be used to build a credit rating. Your credit rating is earned when you borrow money. Responsible borrowing with a credit card can help you to build a higher credit score. If you follow responsible borrowing habits and are careful about how you use a credit card, it can be helpful in improving your credit score. In future, this could help you to secure other forms of credit, such as mortgages or loans.
Using a Credit Card Responsibly
CWhen it comes to using a credit card, it is important to be careful about how you use it. As we said earlier, the safest thing to do is to not borrow money at all and to use your debit card to access funds that you already have in your bank account. However, if you do need to borrow money and can pay it back, then credit cards are often the best way. On top of this, judicial use of a credit card when you actually have the funds to make a purchase anyway can be beneficial for purchase protection, to access rewards and to build a good credit rating. It is important to plan your activity if you are going to use a credit card for these reasons.
Summary: Credit Cards vs Debit Cards
When it comes to debit cards and credit cards, it is generally safer, in daily use, to try not to borrow money and to stick to funds that you already have available on your debit card. Credit cards are best saved for emergencies and should only be used when you know that you will be able to pay the money back. That said they can be useful, if they are used carefully, for accessing purchase protection and rewards and for building a credit rating. If you are planning on doing this, then make sure that you read the terms and conditions of your credit card agreement closely and that you plan your credit card spending carefully. You should only use payday loans as a last resort, after you have considered all of your other options. If you have a debit card or a credit card available, it is generally better to use these first, before you resort to taking out a payday loan.
In the next chapter we will be looking at company credit cards. We will explain what they are and how they are used.