Debit cards vs credit cards

Although they look similar, debit and credit cards function in two very different ways. So when it comes to debit cards vs credit cards, which one is more suitable for you? We take you through the basics, and present some pros and cons to consider when weighing up your options.

When should you use a debit card and when should you use a credit card? The answer will depend on a few factors, including your spending habits and how well you manage your money.

What is the difference between a debit card and a credit card?

When you use a debit card, you are spending money that is in your transaction account- money that you have saved in your own bank account, in other words. When you use a credit card, you are borrowing money to make purchases and you will need to pay this amount back, plus any applicable interest and fees.

Because of this, debit cards are generally a less risky option than credit cards. With a debit card, you can only spend money that you have in your account (unless you have an overdraft facility). With a credit card you are borrowing money, so you can accumulate debt. Your credit score may also be negatively affected if you don’t make regular repayments on a credit card.

Some transaction accounts have overdraft facilities. This allows you to access extra funds (up to an approved limit) if your balance drops below zero. You will typically be charged interest and may also be charged fees if your transaction account is overdrawn.

What is a debit card?

A debit card is linked to your everyday transaction account. It allows you to make purchases and withdraw cash using the money in your account.

You don’t usually have to pay interest on purchases made with a debit card (unless you overdraw your account). Many transaction accounts also do not charge monthly account-keeping fees.

In Australia, debit cards are more widely used than credit cards. According to statistics from the Reserve Bank of Australia (RBA), debit cards were used for nearly 45% of consumer payments in a recent year. Credit cards accounted for 19% of consumer payments.

Compare Transaction Accounts

What is a credit card?

A credit card is a way of borrowing money from a bank or other financial institution. It provides you with access to funds up to an agreed limit. You will then need to repay the borrowed money, plus any interest and fees.

Credit cards typically come with an interest-free period (e.g. up to 44 or 55 days), which is the maximum number of days that you won’t be charged interest on purchases. However, it only applies if you pay your closing balance in full by the due date each month.

Credit cards also have minimum monthly repayments. This is the minimum amount you have to pay to avoid paying late fees, but you will still be charged interest on the amount owing. Credit cards can also come with other fees like annual fees and cash advance fees.

Compare Credit Cards

Debit card vs credit card: pros and cons?

Different payment methods can suit different situations and a debit card may be useful in some circumstances and a credit card in others. Here’s a comparison of the pros and cons of the two cards.

Debit cards

Pros

• Avoid debt – a debit card uses money you already have in your transaction account, so you are not at risk of racking up debt (unless your account has an overdraft facility).
• No interest charges – since you are not borrowing money, you will not be charged interest (unless your account becomes overdrawn).
• Easy to apply for – transaction accounts are relatively easy to apply for and can often be opened in a matter of minutes.

Cons

• Can’t improve your credit score – you can’t improve your credit score by using a debit card.
• No reward points – you also can’t accumulate any rewards points or frequent flyer points with your debit card.
• Some fees – although many cards do not charge annual fees, you may have to pay other fees in specific circumstances, such as overdraft fees and international transaction fees.

Credit cards

Pros

• May be helpful in emergencies – credit cards could be helpful if an unexpected expense pops up and you are short on cash. If you’re only intending to use your credit card for emergencies, consider a card with no annual fee. You could also look at creating an emergency fund.
• Can improve your credit score if used responsibly – if you consistently make your credit card repayments on time, this could help improve your credit score.
• Rewards programs – some credit cards allow you to earn frequent flyer points or other rewards points. Be aware that rewards credit cards typically have a higher interest rate and annual fee compared to non-rewards cards.
• Credit card insurance – some credit cards (typically more premium ones) also offer insurance such as purchase protection insurance and extended warranty insurance.

Cons

• Interest charges – you will be charged interest on purchases you make if you don’t pay off your balance in full by the due date.
• Fees – you may also be charged fees like annual fees, late payment fees, international transaction fees and cash advance fees. Some lenders do offer cards with no annual fees, but they are typically ‘no-frills’ cards with no reward perks.
• Can hurt your credit score – if you miss credit card repayments, this can damage your credit score and make it more difficult for you to get credit or loan products in the future.
• More difficult to apply for – credit cards have stricter application criteria than debit cards and you will typically need to provide proof of income. If you repeatedly apply for credit (such as different credit cards) in a short timeframe and are rejected by different lenders, this may also damage your credit score.
• Risk accumulating debt – a credit card involves borrowing money, so you can risk racking up debt if you are not careful.

If you’d like support with managing your finances, the National Debt Helpline offers free financial counselling and can be contacted on 1800 007 007.

Cover image source: brizmaker/Shutterstock.com