Happy Friday morning everyone! Today is the last Friday before Christmas, so Merry Christmas if you celebrate. Today’s post is about credit cards and debit cards. Which is better? It seems like there’s no middle ground; you’re either all for using credit cards or you think they’re the devil.
About 75% of Americans have at least one credit card, but debit cards remain the most popular way to pay. Credit cards are better than debit cards when used properly, but can be dangerous when used irresponsibly, which might be why so many Americans prefer debit cards. Which should you be using, and should you even be using credit cards at all?
The difference between credit cards and debit cards
When you use a credit card, the bank (or card issuer) pays for your transaction, not you. When you use a debit card, the transaction comes directly out of your own bank account.
Credit cards are more secure because the bank’s money is on the line, not your own; if you have a fraudulent charge or a disputed transaction, the credit card company is going to fight to get their money bank. Debit card users often find themselves out of luck in these types of situations. The protections for credit card users are much stronger than those for debit card users. Even if you don’t like credit cards, you should use one for any big purchases in case something goes wrong.
Credit cards offer rewards, in the form of cash back or airline miles, extended warranties, price protection, and special discounts at certain stores.
Should you even use credit cards?
Dave Ramsey, the biggest name in personal finance, doesn’t believe in using credit cards. He believes that most Americans (at least most of the people that listen to his show) are too irresponsible to use credit cards. I don’t believe that.
If you tell someone they can’t do something enough times, eventually they’re going to believe it. If you treat someone as if they’re not financially responsible enough to use a credit card, they’re not going to be responsible enough to use a credit card. I believe that anyone can use credit cards responsibly. Even if you have a history of irresponsible spending, you can reel it in and use credit responsibly in the future. Preaching a universal lack of self-control, as Dave Ramsey does, is a poor excuse for bad financial habits. Credit cards aren’t the devil, and can be used for good.
How to use credit cards responsibly
Responsible credit card use means paying your bill in full every month and, more importantly, not making purchases with your credit card that you wouldn’t otherwise make. If you’re already following those two rules, you are using credit cards responsibly. If you feel like you spend more on a credit card than you would if you were using cash or a debit card, it may be time to take a break from credit cards for a while.
During your break from credit cards, start a budget if you didn’t already have one. Track every expense; I recommend using an app where you have to manually enter every transaction. This makes it hurt a little more when you buy something. I’m lazy, so I’ll avoid buying things I don’t need because I know I’ll have to log the transaction in my budgeting app. After a few months of successful budgeting and spending, you can begin incorporating credit cards back into your life. Start by using credit cards only for essentials, like gas, groceries, and bills. If you’re successfully using credit cards responsibly, start phasing out cash or your debit card as much as possible. You may struggle with your spending or credit card use, and that’s okay. Feel free to go back to step one and remove credit cards from your life again if you need to.
Credit card rewards and features
Credit cards, unlike debit cards, typically offer rewards and features for using the card. Below are some of the most common credit card features.
Cash back rewards. Many credit cards give you cash back when you use your card, which is usually a percentage of your transaction. Some cards may give between 1-2% cash back no matter where you use your card, for example, and some cards offer more cash back at different types of stores. It’s common for cards to be classified as restaurant cards, travel cards, or gas cards, and offer more cash back on specific types of transactions. There are even store-specific cards that offer higher cash back at one retailer, like the Amazon card, Costco card, and Apple card.
Airline miles. Cards that don’t offer cash back rewards typically offer airline miles instead. These cards are best for frequent flyers; miles may be redeemed for a statement credit or at other stores in some cases, but have the most value when redeemed for travel.
Extended warranties. Many credit cards extend your warranty on purchases you make with the card, which is why it’s so important to make big purchases with credit cards. If you buy a new TV that comes with a one year warranty, for example, simply making the purchase with your credit card could extend the warranty for another year.
Damage and theft purchase protection. Many cards will protect you if your new purchase gets damaged or if someone steals it.
Price protection. Not to be confused with purchase protection, price protection is one of the most coveted credit card features out there. Some card issuers, like Citi, have gotten rid of the feature, but it’s still available on a handful of cards. Price protection means that if you buy something and the price goes down after you buy it, your credit card company will refund you the difference. Of course, you can’t wait forever for the price to drop. You usually have between 30-90 days after your purchase to submit a claim. This is a useful Black Friday hack; if you know something is going to be deeply discounted in the near future, you can buy it at the regular price before it goes on sale and then have your credit card company refund you the difference after the item goes on sale.
Travel and emergency assistance. Many higher-end credit cards offer premium features like travel and roadside assistance. Hopefully this is a feature you won’t have to use, but it’s there if you need it.
Balance transfers. Many cards offer balance transfers with low introductory interest rates. If you have a significant amount of debt on one credit card, you may be able to transfer your balance to another card and save money on interest.
How can credit card companies afford to offer all these benefits?
Credit card benefits may seem too good to be true. They typically have no annual fee (unless you are a high earner and a high spender, it probably doesn’t make sense to have a credit card with an annual fee), yet they offer all of these benefits and rewards to you, the consumer, for free. So how do they do it?
The two biggest sources of revenue for credit card companies are 1.) interest that the consumer pays and 2.) transaction fees that the merchant pays. Transaction fees are typically around 1.75% for each transaction, which is why some smaller businesses charge customers extra to use credit cards. Most larger businesses don’t; this doesn’t mean that credit card users are taking advantage of the corporation by using a credit card, this just means they charge everyone a little bit more.
Only 35% of credit card users pay their bill in full every month. This means almost 65% pay interest to the credit card company every month (those who have an introductory 0% interest rate aren’t charged any interest during the introductory period). Interest paid by consumers is the largest source of revenue for credit card companies. Credit cards are only useful when you pay them off every month; they can be very harmful when you carry a balance. Average interest rates for credit cards are a little over 17%.
The importance of your credit score
Your credit score determines how good of a credit card you can get. If you have a low credit score, the best card available to you may not have many features or rewards. Those with good or excellent credit scores have access to the best credit cards, and also enjoy a lower interest rate than people with poor credit scores. In the future I will be writing an in-depth article about the factors that make up your credit score and how to improve it.
Common credit card myths
1. Carrying a balance every month improves your credit score.
Unfortunately I’ve heard this myth many times. There is a small sliver of truth in there; those who actively use credit cards (but don’t carry a huge balance) will have slightly higher credit scores than those who do not. Credit issuers want to see that you can responsibly use credit cards, but it isn’t necessary to carry a balance. Pay your card off in full every month.
2. Debit cards are better than credit cards.
Credit cards are better than debit cards in every way except one: credit cards allow you to spend more money than you have, and debit cards don’t.
3. Most people are too irresponsible to use credit cards.
The stats show that about 65% of people carry a balance on at least one of their credit cards. The reasons why Americans carry credit card balances, though, may not actually be that irresponsible. 78% of American workers live paycheck to paycheck, which means that carrying a credit card balance may be the least bad option in some cases. It’s better to carry a balance on a credit card than take out a payday loan, and it’s better to use your credit card to fix your car than lose your job, for example. Dave Ramsey wants you to believe that poor people are simply too irresponsible to use credit, and would just spend it on lavish and unnecessary items if given the chance, but in many situations that isn’t the case. When credit cards are being used “irresponsibly,” they are often used by people in difficult situations who have no better options available.
The bottom line
Credit cards are better than debit cards if used responsibly, but if you find that you have trouble controlling your spending when using a credit card, don’t be afraid to take a break from credit cards. I believe that self-control is a quality that people have the power to develop and improve upon, and everyone would be better off using credit cards responsibly rather than not using them at all.
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