Although your credit and debit cards may look alike, there are some significant differences in the way that they work. Understanding the differences will allow you to make the best choice of card for each situation.
When you use a debit card, which is also known as a check card, the money comes directly from your banking account, usually within 24 hours. That means that you must either have enough funds in your account to pay for your purchase, or have signed up for overdraft protection with your bank to cover them. (You'll pay a fee for this coverage.) Otherwise, the merchant will decline your card and you'll have to cover the cost of your purchase in another way.
Using debit cards can get confusing, however, when the cashier asks you "debit or credit?" Even when you choose credit, you're not actually borrowing money as you do with a credit card; you're simply choosing a method for the processing of the payment.
When you use your card as a debit card, you'll have to enter your PIN number to complete the transaction. Banks usually charge a fee for each debit card purchase that you make. When you use your card as a debit card, some retailers also allow you to take out additional cash on your card at the same time. That's not the case when you choose the credit option.
Retailers try to encourage you to choose debit, saying it's more secure because it require the use of the PIN. While that may provide some additional security, the real reason that they care is that they pay lower processing fees when you use your card as a debit card.
When you choose the credit option on a debit card, you're actually asking to have it processed through a credit card network such as Visa or MasterCard. You'll have to sign for most purchases over a certain dollar limit instead of using a PIN. Choosing credit for your debit card transaction also provides some additional financial protection if your card is used fraudulently.
When you use a credit card, you're borrowing money from the card issuer with the understanding that you'll pay it back (or pay at least some of it back) at the end of each billing cycle. You'll be charged interest if you carry a balance on your card from month to month. Your card may be declined if you go over your account limit, or the account issuer may accept the charges but charge you some hefty fees (or raise your interest rates) for exceeding your limits.
Your credit rating will be affected by the way that you handle your credit card account. Your use of debit cards, on the other hand, has no impact on your credit score.
One of the most important differences between debit and credit cards is your liability if the card is used fraudulently, lost or stolen.
When your credit card is used fraudulently, you're liable only for the first $50 of unauthorized use -- and you won't be liable even for that amount if you report a card lost or stolen before the thief has time to use it. (Some credit card companies waive even that $50 liability.)
In most cases, debit cards don't offer the same kind of protection. If you report a debit card lost or stolen within two business days, your liability will be limited to $50 -- and if it's part of the Visa or MasterCard network, that fee will probably be waived as well. If you don't report a card lost or stolen within that 48-hour period, you could end up paying as much as $500 out of your own pocket to cover the fraudulent use of your card.
For suggestions on how to best protect your credit and debit cards, and for more information about your liability limits with each type, read the Federal Trade Commission’s article on Credit, ATM and Debit Cards: What to Do if They're Lost or Stolen