Both credit cards and debit cards are generally used for the means of purchasing goods. However, there are fundamental differences in the way they function and how they benefit the cardholder. Each has its strengths and weaknesses, and understanding the differences between these two types of cards will help you make the decision between which one to choose.
Table of Contents
- What Is the Difference Between a Credit Card and a Debit Card
- Advantages & Disadvantages of Credit Cards and Debit Cards
- Which One is Right For You?
What Is the Difference Between a Credit Card and a Debit Card
A substantial difference between a debit card and a credit card is how they access funds. Both types of cards allow you to make transactions and pay for goods. However, the way in which each type of card pays for the transaction is different. Simply put, debit cards withdraw from a cardholder’s account balance, whereas credit cards acquire funds through a line of credit.
Account Balance vs. Line of Credit
Account Balance: Typically, with a debit card, the money you spend comes directly from the bank account associated with the card. In short, your allowable spend is limited to the amount of money that is in your account; your expenses can not exceed the balance of your bank account.
Line of Credit: This is essentially the total amount of money you can borrow on your card. In a nutshell, a line of credit is a loan from your credit card provider. Each time a transaction is made, that amount is owed back to the provider. Unlike an account balance, with a line of credit, you can potentially increase the amount of money you are allowed to borrow, effectively increasing your spending allowance.
Advantages & Disadvantages of Credit Cards & Debit Cards
Advantages of Using a Credit Card
Strong fraud protection: A fraudulent charge on a credit card can be easily resolved by contacting your provider’s customer service line. Due to the fraudulent charge being made on the line of credit, there is no financial loss to the actual cardholder. Normally, the issue is resolved within a short period of time after the occurrence.
Establish a credit score: Building a credit score is another added benefit to using a credit card. After using a credit card for some time, you begin to build a credit score which is essentially your reputation as a borrower. Once you have an established credit score, you will be able to borrow larger lines of credit for lower interest rates.
Increase line of credit: Credit cards give you the ability to increase the amount of money you can borrow. This means that over time, you can increase your purchasing capacity which will give them the ability to make larger transactions.
Earn rewards and cashback: Almost all credit cards offer some type of reward for usage, such as cashback, discounts, or rebates. They provide various benefits for everyday spend, which can help you save money, earn points, etc.
Emergency payments: In instances where a large emergency purchase may need to be made, a credit card is extremely beneficial to have. Rather than unexpectedly withdrawing funds from your bank account, you can charge your credit card and make smaller payments on the total cost, lessening the impact from the emergency purchase.
Disadvantages of Using a Credit Card
Debt: As a result of being able to spend money that you may not necessarily have, it is quite easy to fall into debt. Without proper management of your spend, over time, various purchases and expenses begin to build up, resulting in significant debt.
Interest on outstanding balance: As a result of borrowing money using a credit card, interest is charged on the outstanding balance at the end of a given monthly period. If you continuously spend more money than you can pay off, you will begin to accrue substantial amounts of debt, and ultimately a growing amount of interest.
Withdrawing cash is typically expensive: In the instance where you need to make a purchase or transaction with cash, credit cards offer a ‘cash advance’ option. Despite the convenience of being able to withdraw cash using your credit card, this method of acquiring it is quite expensive. The average cost of a cash advance is typically 6% of the transaction or a flat S$15 fee (whichever is higher), not to mention a daily compounding interest rate that can range from 24% - 29.9%.
Advantages of Using a Debit Card
No debt: Unlike a credit card, a debit card does not allow you to spend money that you do not have, which means that you can not get yourself into large amounts of debt. Without having to borrow money for spending, the possibility of accruing debt and interest is totally eliminated.
ATM withdrawals: Debit cards allow an individual to have easy access to cash. ATMs are located in many areas around Singapore, so finding one to use is typically a simple task. In the case where you can not find an ATM that is associated with your bank, you can use any other ATM for a relatively low fee.
Disadvantages of Using a Debit Card
Impact of fraud charges: Debit cards are essentially electronic cash, which means that funds from your account are withdrawn at the moment the transaction is made. When a fraudulent charge is made on a debit card, the funds are taken out of the cardholder’s account. This means that you will take a direct financial loss until the funds get reimbursed. This could potentially result in a temporary inability to make other payments from that account.
Limited funds: When using a debit card, you are limited to the amount of money that is in your account. Despite the fact that there are upsides to this, it restricts the purchasing power that you have. With a debit card, there is no option to increase your account balance, whereas credit cards allow you to increase your line of credit. This limitation could potentially prevent you from making certain desired purchases.
Overdraft Fees: Despite the benefits of being limited to your account balance, there is a repercussion to spending more money than the amount in your bank account. Each time your account balance goes into the negatives, your bank will issue an overdraft fee. If you do not frequently check your balance while using your debit card, these overdraft fees can end up costing you a considerable amount of money.
Which One Is Right for You
Deciding on whether a credit card or debit card is right for you, is dependent on a few factors. It is important that you understand your spending behavior before you make the decision of which type of card you want.
When to Choose a Credit Card
Spending behavior: If you are the type of cardholder that can manage your spending and pay off your line of credit within a reasonable amount of time, without accruing large amounts of debt, then choosing a credit card will be exceptionally beneficial for you. Not only will you be able to reap the benefits of associated rewards and discounts, but over time you will be able to build strong credit without being liable to pay an outstanding balance.
Cashback & rewards: Unlike most debit cards, credit cards offer different rewards, discounts, and cashback rates, providing value to those who regularly make purchases in different categories of spend. In the instance where you find a credit card that offers rewards or cashback for a certain type of spend that suits your existing expenses, it is better to choose a credit card as it will offer great value. This will ultimately allow you to draw more value out of your everyday purchases.
Establish credit: If you can manage your expenses and pay your bills on time, you will find that choosing a credit card will offer benefits through building credit. Managing credit card spend and paying off your outstanding balance will allow you to build a credit score and establish yourself as a reliable borrower. This will enable you to increase your line of credit, receive lower rates on loans, etc.
When to Choose a Debit Card
Spending behavior: If you are the type of cardholder that has more difficulty managing your spend, or struggles to make payments on time, a debit card is more suited for you. Using a debit card will limit your spending capacity to the amount of money that is in your bank account. It will eliminate any obligation to pay off accrued debt from borrowed funds. Despite not having as many rewards and cashback opportunities as credit cards, there are still debit cards that offer certain rewards and perks for different types of spend.
When to Choose Both
There are reasons why you may want to have both a credit card and a debit card. Utilizing both of these cards can help reduce your risk of accumulating debt, while optimizing your cashback rewards.
Withdraw cash & earn rewards: Taking advantage of the cash withdrawal convenience of a debit card while earning the rewards benefits of a credit card is a great reason for you to choose both. Not only will doing this allow you to save money with various discounts, rebates, etc. but in the instances where you may need to grab cash, you do not have to worry about paying absurdly high fees and interest rates.
Expensive purchases: When making an expensive purchase, it may be advisable to use both a credit card and a debit card, essentially splitting the cost between the two. Being able to separate the cost and pay part of the purchase initially, while deferring another portion of the cost to a future period of time can help reduce the financial impact of the overall transaction. Not only does this prevent you from withdrawing a large amount of money from your bank account, it also prevents you from potentially accruing interest on such a large purchase.
The Bottom Line: Credit Cards vs. Debit Cards
Ultimately, deciding between a credit card and a debit card is mostly dependent on your spending habits and payment reliability. For some, having the ability to defer payment on transactions while simultaneously earning rewards is quite enticing. Whereas others may not like the liability that is taken on when using a credit card. Understanding how you manage your spending is the key to deciding which type of card is right for you.