The Pluses -- and Minuses -- of Credit and Debit Cards

When we wrote about the downside of debit cards recently, we were flooded with reader comments. Here we explain what's good and bad about debit -- and credit -- cards.

In our November issue, we published a short article -- written by yours truly -- called The Downside of Debit Cards, focusing on how debit cards have fewer protections against fraud than credit cards. It also recommended using credit instead of debit cards for small purchases to avoid liability.

The article unleashed a firestorm from irate readers. Among comments on our Web site:

“Really now? This is just trying to get people to use their credit cards instead of the money they already have.”

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“This is crazy. Tempt people to go into credit-card debt. This is really unsound advice.”

“I have been using a debit card 25 years now and no bank has ever let me pay for something I did not authorize.”

“Don't take this poor advice and get a credit card just to make purchases instead of a debit card.”

“Derricke” even posted a YouTube video titled "Economic Poison: Advice From Credit Card Companies and Kiplinger,” which claimed that we were trying to scare people into using credit cards, ostensibly because we want people to keep spending beyond their means.

Ouch. We understand where the criticism is coming from. But, really, we’re not shills for the credit-card industry, nor would we ever encourage anyone to go into debt by overspending with a credit card.

The point of the article was to alert readers that besides having fewer legal protections than credit cards, debit cards can have significant costs if you are not careful. Overdraft fees from the largest banks average $35 a pop, which rivals credit-card over-limit and late fees. (New federal regulations effective July 1, 2010, will require banks to get your permission before enrolling you in an overdraft-protection plan.)

While it’s true that debit-card users spend only money they have, many responsible credit-card users pay off the balance every month -- avoiding interest charges and taking advantage of a grace period before they pay the bill. Surveys show that more than 40% of credit-card holders pay their entire balance each month.

Credit versus debit cards

Which card should you use when? A lot depends on your attitude toward credit. If you’d rather pay as you go, a debit card is your best option. (It’s risky to carry cash for all purchases, and it’s getting more difficult to use checks.)

But before you decide, consider the pros and cons of credit versus debit cards:

Card theft. Your liability with a credit card is capped at $50; Visa and MasterCard assume all liability for unauthorized purchases. You don’t have the same legal protections with a debit card in case something goes wrong. (See my article for details.)

But if your debit card is stolen or someone has used your number, most banks will credit your account -- at least provisionally -- within a day or two. If you are a responsible customer (who doesn’t repeatedly report stolen cards), the bank is likely to assume all liability -- just as the credit-card issuer does if you’re a victim of credit-card fraud.

Some comments from our readers focused on using the signature side of a Visa or MasterCard debit card instead of punching in the PIN. In that case, you get the same protections as you would with a credit card. We agree.

Disputes with merchants. Credit cards offer stronger legal protections than debit cards in case of disputes about the quality of the goods or services as well as billing errors. Once you notify the credit-card issuer, you do not have to pay the disputed charge while the issuer investigates.

But if you’ve used your debit card, your account must be reimbursed. MasterCard and Visa have similar policies for credit and debit cards, although you may have to sign for your purchase in order to be covered. If you enter your PIN, the bank that issued the debit card ultimately decides whether your complaint is valid.

Your credit score. Using a debit card rather than a credit card to pay bills and make purchases does not affect your credit score. Credit-card payments are reported to the credit bureaus, but debit-card use is not. Your payment history makes up 35% of your FICO score (the most widely used credit score), and that score determines the interest rate you will be offered when you apply for a mortgage, an auto loan and other credit.

Rewards programs. Credit-card rewards programs are usually more generous than debit-card rewards programs. You might have to spend as much as $4 to earn a point with your debit card rather than the standard $1 per point you receive when you use a credit card. You must sign for your debit-card purchase and not punch in your PIN to receive points.

We agree with readers that a debit card helps kick the debt habit and avoid the high fees credit-card issuers sometimes charge. So using a debit card for smaller purchases -- as long as you don’t incur overdraft fees -- makes sense. But when you’re purchasing a big-ticket item, consider using a credit card -- or sign for your debit-card purchase -- to preserve protections.

For another point of view, read how the managing editor of lives without any credit cards.

Senior Reporter, Kiplinger's Personal Finance