The use of credit cards has grown astronomically in the last 20 years or so. What do you know about how they work other than swiping them to make a payment?
What is the difference between a credit card and a debit card? A credit card can be with any financial institution – banks or credit unions. It does not have to be attached to the institution where your checking and/or savings accounts are. When you charge something on a credit card, it becomes a liability for an account all its own. A debit card is attached to your checking account. When you use a debit card, the funds are immediately taken out of your checking account. There is no separate statement, no maintaining of a balance.
Often, individuals will have a debit card that gives them a choice to use it as a debit or credit card. When you use it as a debit card, you enter a PIN to authorize the charge to your checking account. If you use it as a credit card and enter no pin, it creates that separate liability, and an outstanding balance can be maintained.
When you use a credit card, the store owner or service provider is charged a fee. This fee can be relatively low for a business – say 1%, or it can be much higher, in some cases for smaller businesses, even as high as 3%. The business accepting the credit card may also have a flat fee of 10 to 75 cents they have to pay per transaction. This is why you may see some businesses charge a higher rate when a credit card is used, like gas stations. This can be why a merchant requires a minimum to accept a credit card. What business owner wants to pay a 75 cents fee plus a 2.5% transaction fee on a $3 charge?
If you are paying cash, this can provide an opportunity for you to ask for a discount since the business owner will not be incurring those transaction fees.
For business owners, the fee can vary from one credit card service to another. The popular Square credit card provider is known to charge 2.7%, which is high. If you need the convenience of a wireless credit card provider, it might be your best option. If you do not require that feature, you may want to seek out other providers. Maybe your bank’s rate is lower. Places like Sam’s Club and PayPal offer rates that can be lower.
The credit card company is getting fees from the business owner – that percentage and fee per transaction. If you carry a balance on your credit card and pay interest, you are also generating revenue for that credit card company. If you pay your credit card bill late, the company is also charging you a late fee which it gets to keep.
If you use your debit card as a credit card, the issuing bank receives that transaction fee. If you use your debit card as a debit card, a transaction fee is still charged. It can be substantially lower than the credit card transaction fee. Why use a credit card versus a debit card? Is there an advantage to the user for a debit card transaction rather than a credit card transaction?
As an individual, the advantage I see of using your debit card is that the funds immediately come out of your bank account. This means you are not carrying a balance, and you are not paying interest. For many who are living paycheck to paycheck, it provides a means of staying within your budget. If the funds are not in your checking account, you cannot spend them.
The concern with a debit card is the liability. If your debit card information is stolen, that person has access to your bank account. Your entire balance in that account can be gone in minutes. You may incur bounced check fees if you have outstanding checks or auto payments that cannot be made. You may have to spend time with your bill collectors to straighten out this late payment mess. While the bank will get you your funds back, it can take a few days to a few weeks for that to happen. The likelihood is you will need to get a new checking account and a new debit card. You will need to make sure everything gets transferred to that new account – deposits coming in and autopayments going out.
If instead you had used a credit card and someone stole your information, you only must deal with that credit card. You will get a credit on your statement and never have to pay those fraudulent charges. You will need a new credit card. While you are waiting for that new card, you will maintain access to your checking account. It can often be a much quicker process to replace a credit card than to replace a debit card and checking account.
The end result for fraudulent use of a debit card versus a credit card is the same when resolved. How quickly you get the issue resolved can be quite different.
These fraudulent charges and non-payment of outstanding credit card bills are part of what keeps the fees for using credit cards high. Companies are combating this problem in several ways. The chip cards have a lowered fraudulent usage. Many companies are now sending out text or email alerts, maybe even making a phone call when their system picks up a potentially fraudulent charge. The CVV that 3-or-4-digit number on your card helps ensure that you have your card present when making a charge. Many institutions now provide substitute credit card numbers when shopping online rather than using your actual card number.
Another reason for high credit card fees is that revenue is paying for the rewards you earn on your credit. Whether you get travel points, cash back, gift cards, statement credits, or any other number of rewards, the credit card company is paying those rewards out of the revenue they received. That is the 1 to 3% revenue from the merchant and the flat fee if there is one. That is the interest you are paying if you are carrying a balance, and that is the late fees, bounced check fees, overseas fees, etc. – whatever you may pay for using that credit card. If you pay an annual fee, this is revenue generated for the card company.
Being wise in your credit card usage can be lucrative for you or can bust your budget. If you use your card regularly and pay the bill in full each month, that is great. Add the rewards you get on top of the convenience, and you may be making money. For example, my husband and I have gone to both Ireland and Italy purchasing plane tickets and hotel rooms with our credit card travel points. Any of the rewards are great – you need to determine which is the best for you.
If you carry a balance on a credit card, getting the rewards is generally not as beneficial. Think about the interest you paid to earn those rewards. If you are adding late fees or an annual fee, do you really benefit from those rewards? Generally, the recommendation would be to stop using the card until the balance is paid off, and you will get a bigger bang for your dollar.
Not sure if you have the best card for your personal usage? Try reviewing a website like NerdWallet.com or Bankrate.com who can help you determine where you will get the best benefit for the way you use a credit card. And of course, here at Planning with Purpose, we are also always willing to help!!