Credit cards and debit cards have become an integral part of most people’s day to day financial lives but in my experience are two financial products commonly confused.
‘What’s the difference between a credit card and a debit card?’ is probably the most common question I get asked by young people (my friends really are imaginative) so here’s a definitive explanation.
Prefer to watch than read? Here’s my quick video explainer:
Debit Cards
A debit card is a type of payment card which is linked to your bank current account. When you make a payment, the money is taken (debited) from your bank account meaning in normal circumstances, debit cards are not a debt product.
However, on many bank accounts, you can opt for an overdraft which allows you to continue making debit card purchases and transactions even if you don’t have the money in your account. This means that your current account balance would show a negative figure and you would owe the bank the money.
Overdrafts now come with a very high interest rate (often higher than credit cards) so this is an expensive way of borrowing money. Although in some circumstances (such as at university where many banks offer an interest free overdraft) it can be a useful tool to manage your personal cash flow although this should be done with great caution!
Debit cards come with chargeback protection on any purchases regardless of the amount although you must claim within 120 days of your payment making it less useful than Section 75 protection on credit cards.
Credit Cards
A credit card is a type of borrowing product which allows you to make purchases without taking money from your bank account straight away, instead, you owe the bank the money at the end of the month. Credit cards often have high interest rates (20 to 30%) although if you pay the balance IN FULL at the end of the month you can avoid interest charges.
The high rates of interest charged on most credit cards can cause particular issue if you only repay the minimum the bank stipulates each month. This is because compound interest allows the amount you owe to increase to the point where if you borrowed £3,000 on a credit card at 21 and only made the minimum repayments, you’ll be
almost 50 before it clears!
Despite the dangers, credit cards can be incredibly useful as some offer rewards for spending on them (which if done responsibly can be a good source of free cash) and they have Section 75 protection.
Section 75 of the Consumer Credit Act 1974 (my favourite financial regulation) means that the credit card company is jointly liable with the retailer for amounts between £100 and £30,000 meaning that if your purchase goes wrong you can always rely on your credit card.
In addition, there are different types of credit cards such as balance transfer cards (clear debts on other credit cards at a lower rate), money transfer credit cards (pay money into your bank account which is then owed to the card company) and credit (re)build cards which help you build up a credit history.
As you now see, debit cards and credit cards are vastly different financial products and don’t share many similarities beyond being plastic cards. Both can be very useful but also have their drawbacks.
Do comment your thoughts below.
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