The gist: Debit cards draw funds directly from your bank account, whereas credit cards draw on a line of credit to pay for purchases and must be repaid at the end of the payment period.
A debit card, which looks and feels just like a credit card, draws funds from your bank account every time you make a purchase. Your spending ability is limited by the amount of money you have in your bank account. If your bank account balance reaches zero you usually cannot use the debit card until you add more money to the account.
In contrast, a credit card covers the cost of the purchase for you then requires you to repay later. The credit card issuer limits the amount of spending that they’ll cover. They also charge an interest rate on any balances that you don't pay by the due date each month.
What is a credit card?
A credit card is a way to pay for things by borrowing money. The financial institution that issues the card, usually a bank, allows you to spend up to a certain amount and requires repayment each month when you receive the bill.
The credit card issuer will only allow you to borrow up to a certain amount. This amount is called a credit limit. When people say that they’ve “maxed out” their credit card, they mean that they have reached their credit limit and cannot spend anymore until they pay down the balance.
Credit cards have an annual percentage rate (APR). This is the interest that you are charged on any unpaid balance. When this balance is carried from month to month the interest grows on a daily basis. This daily interest charge is called the Daily Periodic Rate (DPR). This number is the APR divided by 365.
For example, a credit card with a 20.34% APR has a DPR of 0.0557%. Therefore, if your credit card balance is $700, then your daily interest charge is $700 x 0.000557 which equals $0.38
From here it’s easy to calculate the monthly interest rate. Simply multiply $0.38 by the number of days in the billing cycle (which is usually 30). In this case the monthly interest charge comes to $11.40. Over time this number can add up if there is a balance carried month after month.
The credit card issuer reports your payment history to credit bureaus. Your history is used to calculate your credit score. Your credit score will rise if you have a long history of on time payments. A higher credit score means that you are more likely to get approved for loans. A high score also means that you are more likely to get lower interest rates on those loans. A lower score means you are less likely to get approved for loans.
What is a debit card?
A debit card is a simpler payment method because it doesn’t involve interest rates or lines of credit, or credit history reporting. When you spend with a debit card you are simply pulling money from your checking account. This is why you can use a debit card at an ATM to withdraw cash.
Some debit cards have a daily purchase limit. This means that you cannot use them to spend more than a certain amount in a day even if that amount is less than your total balance.
In most cases a debit card doesn’t have any fees or costs to worry about. However, there are some cases where a fee might come into play. For example, some debit cards will charge a small fee for using them at an ATM that is not affiliated with your bank. Additionally, if you spend more than the total amount of cash in your checking account the bank will charge you an “overdraft fee” or an “insufficient funds” charge.
What are the different types of credit cards?
There are several different kinds of credit cards. Each is designed for a particular kind of spender. Some are for people who travel a lot. Others are for students who are young and still establishing their credit history.
The most common types of credit cards are:
Reward credit cards
These cards offer points and cash-back based on a percentage of your spending. In some cases the rewards differ based on your spending levels in categories like travel, dining or gas. You can redeem points for merchandise, gift cards or a discount on your statement balance.
This kind of credit card has several subcategories:
- Flat-rate: Earn a fixed percentage of cash back on all spending, usually 1.5% to 2.0%
- Tiered-rewards: The cash-back percentage differs based on the purchase category
- Rotating bonus: The bonus purchase category changes monthly
- Travel rewards: You gradually earn free travel as you spend more
Low interest credit cards
Low interest rate credit cards offer an initial period during which the APR is 0%. This period usually lasts for about 15 to 18 months after which the APR returns to a normal rate. Today the average APR for all new card offers is about 23.55%.
This category also includes balance transfer credit cards. These cards allow you to move debt from your old credit card onto a new one with a lower APR. For example, some cards offer a 0% APR for 18 months on balance transfers. This means that you pay no interest for 18 months on the balance that you move onto the new card. Again, after the 18 month period ends the card returns to a normal APR.
Introductory credit cards
These credit cards are for people who are new to using credit or need to work on boosting a low score. Some of these cards have built-in features which help prevent overspending. Others have less strict application requirements.
Examples of introductory credit cards include:
- Secured cards: The credit limit is backed by a cash deposit that you make
- Student credit cards: These often require no credit score and have no fees or rewards
What are the different types of debit cards?
Debit cards have less variation than credit cards which are designed for a range of spending habits. However, there are a few minor differences among different debit cards.
Standard debit card
This is the most basic type of debit card. The card is linked to a checking account or a money market account. You can use it online or in person and at ATMs.
Prepaid debit card
Prepaid debit cards are not linked to a traditional checking account or money market account like a standard credit card. Instead, you must load the card online, at an ATM or at a participating store. In some cases an employer may offer this kind of debit card to an employee that doesn’t have a bank account. Some government programs also use them as a way to dispense money.
Electronic Benefits Transfer card (EBT)
Government agencies issue EBT cards as part of an assistance program. The government agency is the only entity that can load money onto the card. The card holder can only use it for approved purchases.
These debit cards can only be used at an ATM. You can make deposits into the account. The card cannot be used to make purchases the way you can with a standard debit card. ATM-only cards have a daily withdrawal limit.
When should I use a credit card instead of a debit card?
There are a few scenarios when a credit card is better than a debit card:
A credit card is a great choice when you are trying to build your credit. By using the card and paying the balance in full and on time you are slowly increasing your credit score.
A credit card is also a great choice when you want to benefit from the points and cash-back rewards. For example, if you dine out frequently or travel often you can save big if you have a tired-reward card that prioritizes these spending categories.
A credit card is a great choice when renting a car. Why? Because most credit cards offer insurance for damage and theft. This insurance takes effect after your personal insurance pays. In some cases the credit card will even reimburse your auto insurance deductible.
Sometimes there isn’t enough money in a checking account to cover a large purchase. This is especially true when the purchase is an unforeseen emergency like a new hot water heater for a home or major repair to your car. A credit card helps spread out these big expenses.