While debit cards, charge cards, and credit cards are all made of plastic and share the same space in your wallet, they each have distinct features and drawbacks. Read on to figure out which one is right for you.
Credit cards usually come with a set credit limit (say $500, $2,500, or $25,000) based on the cardholder's credit rating and income. Credit cards allow consumers to carry a balance from month to month, on which they must pay interest. In general, a credit card issuer will raise your credit limit as you spend more and make regular payments. If you habitually pay late or miss payments, your limit could be reduced or your credit cut off. The issuer might also raise the interest rate on the remaining balance.
Shop carefully when selecting a new card. An attractive offer of no annual fee might be accompanied by an exorbitant interest rate as high as 30%. If you have no credit history or poor credit history, consider obtaining a secured card. In exchange for a deposit of $200 to $500, a bank will issue a credit card with an equal spending limit. This allows the cardholder to establish credit while earning interest on the deposit.
When you think of charge cards, you often think of American Express. Unlike credit cards, charge cards do not have a monthly spending limit. You can charge virtually an unlimited number of purchases to your card, but need to pay the balance in full every month. To encourage you to do so, charge cards generally impose a fee and penalties on unpaid balances.
Like credit cards, some charge cards assess an annual fee. Despite the fees, many consumers prefer charge cards because they avoid the interest-related expenses that come with credit cards.
Debit cards work like old school checks. When you make a purchase with a debit card, the payment is taken directly from your linked bank account. If your account has insufficient funds, your card payment may be declined. Some banks, however, offer overdraft protection which will cover a transaction up to a set dollar limit, in the event of insufficient funds, or transfer the necessary funds from another linked bank account, should you have one.
Online, debit cards function like credit cards. You need to provide the merchant with the card's number, expiration date, and validation code to complete a purchase. Offline, your debit card functions much like an ATM card. You need to enter your personal identification number (PIN) to initiate the transfer of funds from your bank account to the merchant's bank account.
If you want to curb your spending and avoid the urge to buy stuff you can't afford, debit cards are a good choice. The money comes directly from your bank account, there are no interest charges and generally no fees. Visa and MasterCard affiliates issue most debit cards, so most merchants that accept Visa and MasterCard credit cards will also accept debit cards.
However, debit cards have fewer protections against fraud compared with credit cards, and it can be more difficult to get your money back. One other point: because you're paying with your own money, debit cards don't help you build credit history and improve your FICO score.
The Bottom Line
Putting plastic in your wallet is a convenient way to buy things and avoid carrying cash. And if you participate in various perks programs offered by credit cards and charge cards, you can earn airline miles or other rewards with each purchase.
From a financial perspective, debit and charge cards are structured so they pose little danger to your financial wellbeing. They discourage or make it impossible to carry a balance, so the temptation to buy what you can't afford is minimized.
Credit cards, on the other hand, have been an instrument of financial ruin for more than a few careless consumers seduced into living beyond their means. Interest rates border on the obscene. Minimum monthly payments can stretch a purchase's payback period for years. To avoid these pitfalls, pay attention to your spending habits. Keep in mind that being able to afford the minimum monthly payment doesn't mean you can afford the purchase. It simply means that if you buy an item, not only will you be in debt, the interest payments will increase the total cost of the item to well beyond the sticker price.