Outwardly, a credit card looks the same as a debit card. In some ways, they even function the same. Both use cards–instead of cash–to complete transactions. If you’re relatively new to the world of finance, you may wonder: how is a credit card different than a debit card? We’ll break down the main differences in this handy article.
A credit card is essentially a line of credit offered by a financial institution such as a bank. When you apply for a credit card, the issuer will first check your credit history to determine approval. If your credit report is good, you’ll get approved. When issuing your card, the issuer also sets a specific credit limit based on your credit history. This credit limit is valid for one billing cycle, which is usually one month.
You can use your credit card to purchase items or withdraw cash up to the specified credit limit. At the end of each billing cycle you pay for all the items you purchased by the payment due date. If you’ve reached your limit and need extra credit, one way to do this is by paying off what you owe mid-cycle. This will increase your credit by the amount that you’ve paid off. Your credit limit gets re-set at the beginning of each billing cycle.
To get the maximum benefits of your credit card, you must pay the balance in full by the payment due date. If you miss a payment, the issuer will charge you a late payment fee as well as interest on the outstanding amount. Interest on late payments can be shockingly high and send you further into debt. Making on-time payments will help you avoid late fees and interest. It will also help you build your credit score. On the other hand, late payments will do major damage to your credit score.
A debit card is linked directly to your checking account. It allows you to buy items by deducting money directly from this account. A debit card is also issued by a bank but the eligibility criteria is different. All you need to own a debit card is an account at that bank. The bank will issue you a debit card based solely on your account. Your credit score is not factored into the decision.
A debit card allows you to purchase items by drawing on funds from your bank account. When you use your debit card, the purchase amount is deducted directly from your account. This deduction is instantaneous and occurs as soon as you swipe your card. The limit on your debit card is equal to the amount of cash that you’ve deposited into your bank account. You cannot spend more than that. If there’s insufficient cash, your purchase won’t go through. In order to use your debit card, you must keep a running balance of your checking account.
With a debit card, there’s no question of late payments or interest. Also, it has absolutely no impact on your credit history.
If you’re trying to decide between a credit card and a debit card it helps to understand the differences between the two.
Application requirements: You must have a high credit score and strong financials to qualify for a credit card. To get a debit card all you need is a bank account.
Payment convenience: A credit card allows you to ‘buy now pay later’ up to your credit limit set by the issuer. This means you can purchase items even if you don’t have any balance in your bank account. A debit allows you to buy only if you have a cash balance in your bank account. Your spending limit is determined by your bank balance.
Fees: Most credit cards have an annual fee. Debit cards don’t have any fees.
Cash withdrawal: You can withdraw cash at any ATM with both, a credit card as well as a debit card. You won’t incur any fees or interest when you withdraw cash at an ATM using your debit card. However, you will pay a cash advance fee and a steep interest rate if you use your credit card to withdraw cash.
Rewards: Credit cards come with all sorts of rewards and perks, from discounts to flying miles and hotel stays. There are no rewards or perks associated with debit cards.
Credit Score Implications: Using a credit card is a great way to improve your credit score but only if you make all payments on time. A missed payment can damage your credit score and will remain on your credit report for seven years. A debit card won’t help you build credit and has no impact at all on your credit score.
Penalties: You will incur a steep late penalty fee and interest if your credit card bill is not paid by the due date. There are no penalties associated with debit cards.
A credit card is a powerful financial tool that offers a fantastic combination of convenience and rewards. The biggest benefit of credit cards is the ability to use them to build your credit score. If you can trust yourself to be financially responsible, a credit card is definitely a great choice.
With a debit card, you can only spend what you have. There’s no way to overspend, which helps you steer clear of debt.
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