As a financial coach, I advise clients to use a debit card instead of a credit card. Some find this a bit confusing so I will explain why a debit card is recommended and a credit card is not. First of all, they can be used at the majority of the same places for purchases, car rental (with a few exceptions) and booking and paying for hotel stays.
The main difference is one acts as cash, that’s the debit card. A credit card is a temporary loan normally from a bank. Essentially, it’s borrowed money and as a financial coach I don’t want you borrowing money.
- Debit cards draw money directly from your checking account when you make the purchase. They do this by placing a hold on the amount of the purchase. Then the merchant sends in the transaction to their bank and it is transferred to the merchants account.
- Credit card is a card that allows you to borrow money in small amounts at local merchants. You use the card to make your basic transactions. The credit card company then charges you interest on your purchases, though there is generally a grace period of approximately thirty days before interest is charged if you do not carry your balance over from month to month.
Let’s look at it from a bank’s perspective. A debit to your account is taking money out of your banking (normally checking) account and a credit is putting money into your account (in this case a temporary loan). When a bank issues you a credit card, they are giving you a line of credit, this is essentially a virtual deposit. While you don’t see it as a deposit to your account, when you make a purchase you have now used a portion of the virtual deposit. Keep in mind this comes at an opportunity cost, in the form of interest. So if you don’t pay the balance at the end of the month (most people don’t) you now incur a finance charge.
For example let’s say you have a 1000.00 credit limit and annual interest rate is 12 percent, when you purchase something for 100.00 and don’t pay the balance when due you incur a 1/12th charge for that month, which would be 1.00. Your opportunity cost was 1.00 for that month, if you didn’t pay the 100.00 for the whole year that cost would increase by the new balance and the 1/2th per month interest.
So if your goal is to get out of debt, save and invest for your future don’t use a credit card.
Cash is still king.