Are credit cards and debit cards considered debt instruments?

By Albert Phung AAA
A:

Consumer debt instruments allow people to borrow money at specific interest rates. In recent years, the credit industry has become very imaginative in the creation and marketing of consumer debt instruments and, as a result, there is a lot of overlap between debt and non-debt instruments.

By definition, all credit cards are debt instruments. Whenever someone uses a credit card for a transaction, the card holder is essentially just borrowing money from a company, because the credit card user is still obligated to repay the credit card company. Credit card companies generally make money off of credit cards by charging high interest rates on credit card balances.

Debit cards, on the other hand, are not debt instruments because whenever someone uses a debit card to make a payment, that person is really just tapping into his or her bank account. With the exception of any related transaction costs, the debit user does not owe money to any external party because the money used in the debit transaction came from the available funds in the user's bank account.

However, the distinction between debt and non-debt instruments becomes blurred if a debit card user decides to implement overdraft protection. Whenever a person withdraws more money than what is available in his or her bank account, overdraft protection can come into effect and the bank will lend the person enough money to cover the transaction. The bank account holder is then obligated to repay the account balance owed and any interest charges that apply to using the overdraft protection.

Overdraft protection is designed to prevent embarrassing situations, such as bounced checks or declined debit transactions. However, this protection does not come cheaply; the interest rates charged by banks for using overdraft protection are as high, if not higher, than the ones associated with credit cards. Therefore, using a debit card with overdraft protection can result in debt-like consequences.

To read more, see Credit, Debit And Charge: Sizing Up The Cards In Your Wallet and Take Control Of Your Credit Cards.

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