Credit and debit cards look identical, but in reality they’re two very different ways of payment.
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With a debit card, typically tied to a bank account, funds must be added in advance to an account before any transaction can be performed. A prepaid card is a type of debit card that is a stand-alone product, not tied to a bank account.
Alternatively, credit card issuers consider every transaction to be a loan to the cardholder.
By acting as a loan, a credit card gives users the flexibility to access additional funds beyond what they currently have available in their bank account. This can be helpful when you need to make a purchase and do not have the cash to do so, such as a car repair. However, this convenience could also allow people to live beyond their means and acquire too much debt.
Other types of cards you may see or hear of include secured cards. With secured cards, customers must first submit a security deposit, which then becomes their credit limit. Yet in all other ways, a secured credit card is used just like any other credit card. Cardholders must pay their bill every month, and they can incur interest when they carry a balance.
Credit cards also offer a host of features debit cards do not. With a credit card, you can:
Build credit history
Because credit cards are effectively loans, all accounts will appear on your credit report and contribute to your credit history. And since every credit card payment is actually a loan repayment, each one is reported to the major consumer credit bureaus, helping you to improve your credit history and to potentially raise your credit score when you pay your bills on-time. (The higher your credit score, the better interest rates you may get for future loans, such as mortgages.)
This is even true when you avoid interest charges on new purchases by paying your statement balance in full each and every month. Most debit card accounts do not appear on your credit report and do not help you build credit. Building credit history is essential for loans, renting and much more.
Protect yourself from fraud
Credit card users are protected by the Fair Credit Billing Act, a powerful federal law that protects consumers in the event of unauthorized charges, and even undelivered goods and services. The law states that cardholders who notify their card issuer of any unauthorized charges will not be responsible for more than the first $50 of charges. 1 (However, Discover cardmembers are never responsible for unauthorized purchases on their Discover card.)
While debit card users are also protected against unauthorized charges, their liability can be as much as $500. 2 They also lose access to their funds until they are able to prove the charge was unauthorized, a process that can take weeks.
Protect yourself from unreliable merchants
Credit card users are also protected when a charge is authorized, but the merchant fails to deliver the goods or services as promised. When this happens, credit cardholders can request a chargeback, which immediately results in a temporary credit that becomes permanent once the claim is documented. For example, if a merchant goes out of business before delivering goods or services that you’ve already paid for, you are protected if you used a credit card. Unfortunately, when a charge to a debit card is initially authorized, but the merchant fails to deliver goods or services, the debit card issuer can’t offer the cardholder the option of a chargeback or any other recourse.
Enjoy rewards and benefits
Many credit cards offer users valuable rewards, such as miles and cash back. Additionally, credit cards also provide a wide range of benefits not found on debit cards such as purchase protection, extended product warranties, price protection policies, and return guarantees. When traveling, credit card users can also enjoy benefits such as flight accident insurance and auto rental insurance. All of these rewards and benefits are usually not offered with a typical debit card.
Rent a car and reserve a hotel
Finally, credit cards can be extremely useful when renting a car or checking into a hotel. In both of these cases, customers need to provide a security deposit in some form to be used in the event of damages. When using a credit card, the deposit comes in the form of a temporary authorization that only places hold on the cardholder’s line of credit. But with a debit card, the deposit is in the form of a hold on the cardholders existing funds, and that hold may not be released until several days after the cardholder returns the rental car or checks out of the hotel.
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As both debit and credit cards evolve, consumers are constantly evaluating the advantages and disadvantages of each form of payment. By understanding these key differences, you can choose the product that best meets your needs.
Next article in series, What are the Benefits of Using a Credit Card