Debit and Credit Cards

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Overview

People tend to get debit cards and credit cards mixed up. They are both cards that allow you to pay for purchases, and they both look very similar. There is, however, a difference in where the money comes from when you use each card. It is not uncommon to have access to both, but deciding which card to use in order to pay for a transaction will depend on your finances. There are pros and cons for each.

Understanding Debit Cards

When you use your debit card to make a purchase, the money comes straight from the checking account that your card is linked to. Therefore, you are using the money that you own. Using your debit card to pay for transactions when you are at a store or restaurant is convenient, because you don’t have to worry about whether or not you have enough cash in your wallet. You can also use it to pay bills and buy items online, or to withdraw money from an ATM (Automated Teller Machine). Debit cards are a great tool to use because unlike credit cards, which you will read about later on in this lesson, you do not have to apply for a debit card. You can get one even if you have a low credit score or bad credit history. All you need is a bank account.

Understanding Credit Cards

Unlike a debit card, when you use your credit card in order to make a purchase, the money does not come from your bank account. Instead, you are borrowing that money from the bank or company that issued your credit card. In turn, that bank or company will send you a bill, and you will have to pay back that amount later on. You can almost think of it as a loan. You borrow the money from the company, but while they are waiting for you to pay them back, they are charging you interest. Interest rates vary by company, but normally they range anywhere from the low teens to percents the mid-20s. For each billing period, you will be required to pay back a portion of the amount you borrowed, plus interest.

Due to interest charges, you’re actually spending more than you originally paid. The only way to avoid getting charged interest is to pay back the full amount within 30 days. Be aware that some companies start charging interest immediately. On the plus side, some credit card companies offer rewards when you use your credit card. The type of reward varies depending on the company and type of credit card. Rewards can be anything from earning cash back, airline miles, retail rewards, or gasoline points.

Just like you would with a loan, in order to get a credit card, you must first apply for one. Banks and companies will look at your income, credit score, and credit history in order to determine if they believe you are in a good enough financial situation to be able to pay them back. This is also the information they use to determine your credit card limit. If they like what they see and feel confident that you will pay them back, you will get approved. If not, your application will be denied. If denied, a debit card is always an option.

Keeping Track of Credit Card Spending

It is important to keep track of credit card spending so you can make sure to keep your balance(s) at a manageable amount. Credit card debt can quickly get out of hand, and one way to prevent that from happening is to always know how much you are spending, what you are spending money on, and what your current balance is on each card. Some people have multiple credit cards. The more credit cards you have, the easier it is to lose track of your spending.

If you just want a general idea of how much you are spending, you can create a list with each credit card, along with its balance, at the end of each billing cycle. You can create your list on a piece of paper, in a notebook, or if you enjoy using technology, you can keep a spreadsheet of the information. Spreadsheets are convenient because the formulas will do some of the math for you.

If you want a more in-depth look at your spending, like how much you are spending on gas, groceries, bills, etc., then you would need to use an online tool, app, or accounting software. Accounting software can get expensive, but there are plenty of affordable, and even free, online tools and apps at your disposal. Check out the Lesson Toolbox for ideas.

Choosing the Right Credit Card

Before choosing a credit card, you’ll want to compare certain features for each card you are considering. You’ll want to compare the interest rate, any applicable fees, reward options, and what the minimum repayment percentage is each month. You can also find comparison websites online that will help you compare your options, all on one page.

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Anytime you apply for a credit card or loan, like a mortgage, auto loan, student loan, or personal loan, the lender will first check your credit score. If you are trying to rent an apartment or house, your credit score will likely be checked by the landlord. After reviewing your credit score, current income, and job history, they will decide whether or not to approve or deny your application. It is a good idea to keep an eye on your credit score so that you have an idea of what your score is before applying.

Credit Score Ranges

Credit scores typically range from 300 to 850. The higher the score, the better your credit is. Credit scores are broken into different ranges. The ranges are as follows:

Below 600: Very bad
600-650: Bad
650-700: Good
700-750: Very Good
Above 750: Excellent

How Credit Scores are Calculated

Credit scores are calculated based on several factors, such as your payment history, the length of credit history, credit usage, and credit types. A higher credit score means you have made your payments on time, your balances aren’t too high, and you have a longer length of credit history. If your credit score is on the lower side, it could mean that you made late payments, skipped payments, have high balances, and/or you have a shorter length of credit history. Any sort of repossession or foreclosure can greatly impact your credit score. Negative actions will normally stay on your credit report for 7 years. Filing for bankruptcy is an exception, and remains on your credit report for 10 years.

Credit Reports

A credit report provides information about your credit history, including your credit score and personal information. A full credit report will give you an idea of where you are lacking and what you need to do in order to increase your score. There are numerous companies that offer credit monitoring, as well. This is useful in case someone attempts to steal your identity. Getting your identity stolen can take a toll on your financial situation, and going through the process of repairing it can be time consuming and stressful. The quicker you catch it, the less damage will be done.