Spending Smart: Weighing Debit Against Credit

This column is for you: the everyday college student, whether you are graduating this year or just beginning your college journey. Understanding the fundamentals of personal finance is essential for long-term financial success, and making informed decisions about credit and debit, rent, bills, insurance and more is an important step in adulthood. As a finance student at Sy Syms, I am often asked personal financial questions. While I don’t have all the answers, the frequency of these conversations suggests that many can benefit from a stronger grasp of the basics of personal finance. While some of the topics discussed here may be familiar, I welcome suggestions for additional topics you’d like me to cover. I hope this column is the first step in many that you take towards achieving a successful financial life. 

As college students and adults entering the “real world,” we are soon to face many important financial decisions. It is important to develop an understanding of the financial concepts and instruments that underpin modern personal finance to ensure a successful future. Debit and credit cards are two such instruments that can aid one in achieving financial success or drive one into financial despair. Understanding the similarities and differences between the two is key to making sound financial choices.

Debit cards and credit cards are both physical plastic or metal cards that can also be stored in digital wallets and used to pay for in-person or online purchases. Both offer an additional degree of convenience and security compared to carrying cash and are widely accepted by merchants. That’s where the similarities end. Beyond these, each serves a distinct purpose, each with its own advantages and drawbacks.

Debit cards are linked to your checking account. Purchases made using a debit card are withdrawn directly from the account, meaning there is no bill due at the end of the month. Many people appreciate this safeguard against overspending, as it limits them to spending only what they actually have. However, it is possible to overdraft, meaning making a purchase that exceeds the balance of the account. Some banks offer overdraft protection and will decline transactions when there are insufficient funds in the account; others will allow the purchase to go through even if it results in a negative balance and charge an overdraft fee.

Some common debit card fees charged to customers include ATM fees, overdraft fees and foreign transaction fees. ATM fees are charged when you use your debit card to withdraw physical cash from your account at an ATM. Some might charge a nominal fee for that transaction, and others will charge a percentage. Overdraft fees occur when you spend more money than you have, resulting in a negative balance in your account. Banks may also charge foreign transaction fees, typically around 3%, for purchases made outside of the United States. 

Credit cards, on the other hand, are a far more complex financial product that allows cardholders to access a line of credit. A line of credit is an option offered by a bank that allows individuals to borrow money whenever they make a purchase using their card. Cardholders are responsible for making minimum payments on their balance at the end of the month, and the remaining balance is subject to interest until paid off. 

Credit cards typically have credit limits set by the bank based on a customer’s income, credit score and payment history. A credit limit is the maximum the bank is willing to lend a customer at any given time. Customers can continue to make purchases on their card until this limit is reached, and they are billed for them in monthly statement periods. Cardholders have at least 21 days after the statement closing to pay for charges and avoid interest payments. If customers choose only to make minimum payments and not to pay off their statement and “carry a balance,” they will accrue interest charges at an APR (annual percentage rate) that can easily exceed 20%. 

Different credit cards and cardholders have varying interest rates, and it’s essential to consider these rates when obtaining or evaluating a credit card, and when deciding how much to spend and pay off. Failing to use credit cards responsibly can quickly lead one down a financial rabbit hole that is difficult to recover from. For example, making a purchase on a credit card and failing to pay it off at the end of the month will result in interest being charged at a rate of approximately 2% per month. Making only minimum payments, which typically account for only around 2-3% of the total balance, means that most of the payment goes towards interest, and the bulk of the principal balance lingers. Interest continues to accrue on the principal, and the debt can stretch out for years, with the borrower ultimately paying significantly more than the original purchase amount. This dynamic may help explain why credit card debt in the United States has ballooned to over $1.2 trillion.

In addition to this, credit cards can also impose late payment fees if bills are not paid on time, cash advance fees and balance transfer fees for borrowing cash or transferring balances, and foreign transaction fees similar to those charged on debit cards. Some credit cards may charge annual fees to the cardholder that can cost hundreds of dollars annually. Consumers pay these fees because they will get benefits and perks from their credit card company, such as airport lounge access, travel and rental car insurance, special promotions and exclusive concierges.

Some advantages of credit cards include exclusive rewards at select merchants, the ability to earn cashback or points on purchases and the ability to transfer points as miles to your preferred airline. Obtaining a credit card is also a way to establish good credit. A credit score is a way for loans, banks, car dealerships (any financial institution that you’ll need a loan from in the future, including mortgages) to gauge your likelihood of paying back your debts on time and in full. A good credit score indicates to lenders that you’re reliable to repay loans on time and improves your odds of getting approved for a loan and qualifying for a preferred interest rate. Credit cards also allow flexibility and allow people to pay for things over time. When there is a major expense that needs to be made or a financial emergency, having a backup like a credit card can be very helpful.

While the promise of credit cards with free short-term interest, points and perks is alluring, mismanaging a credit card can quickly lead to overwhelming debt. The best practice is to treat a credit card like a debit card, only spending what you already have and paying the balance in full each month to avoid interest, while continuing to earn points, benefits and rewards. 

As the world becomes increasingly digitalized, more people are opting for payment with debit cards and credit cards versus cash. Both tools can be powerful when used responsibly, but dangerous when mismanaged. It’s essential for people to make informed financial decisions before getting a card and to understand where their money is going and how it’s being used. 

The information provided in this article is for educational and informational purposes only and should not be construed as financial advice. Readers should consult with a qualified financial advisor or other professional before making decisions regarding their personal finances.

Photo Caption: A person holding credit cards. 

Photo Credit: Unsplash / Avery Evans