Answering The Question: Debit Or Credit?

Debit Vs. Credit: The Basics

Debit cards look like credit cards, and many have a Visa or MasterCard logo on them, but they don't work the same way. The main difference is that debit cards use the money from a linked checking account, and credit cards use money that you borrow and pay back later.

You are given a debit card by your bank or credit union when opening a new account. Instead of carrying around checks or large amounts of cash, a debit card enables you to make purchases by taking the money out of your checking account. It can also be used for quick and easy access to cash by withdrawing money from an ATM.

A credit card works like a loan and allows you to borrow money when paying for purchases. Each month, the cardholder is sent a bill for the amount that was spent using the card. Though only the minimum payment is required, interest accumulates on the unpaid balance.

Answering The Question

The primary differences between selecting debit or credit is the method of payment and the network used to process the payment. When processed as a debit transaction, the "funds are debited immediately from your checking account, and you must enter your PIN," according to WenFang Bruchett, founder of BlissFinance.

Consumers opting for PIN-debit transactions are authorizing the merchant to process their purchase as an electronic funds transfer through networks like Star, Pulse, Interlink or NYCE.

If the shopper chooses credit when using a debit card, the purchase runs through a credit card network, like Visa, MasterCard or AMEX. Bruchett cautions that the "card networks may offer zero liability for fraudulent purchases, but this varies from financial institutions."

Note that credit transactions on debit cards may take a few days to appear on your bank account, because they are processed offline by the credit card network. Debit transactions typically are generally reflected on your account much sooner, if not immediately.

When choosing between debit or credit, it's important to understand that the credit option isn't a credit purchase at all. Even if the credit option is selected, it's a debit transaction because the funds are taken directly from the cardholder's checking account. This makes debit cards more vulnerable to fraud than credit cards.

When using a debit card, "you have provided direct access to all of your money," warns William Bradley, a financial expert who co-authored Winning the Credit Score Game. Bradley goes on to say, "the identity thief can go forward until it's all been used, and once the other purchases start to be returned due to insufficient funds, then you have that mess to clean up, as well."

Consumer Protections And Liability

Most shoppers don't realize traditional credit cards are much safer and they're opening themselves up to an increased risk of fraud by using a debit card. When using a credit card, criminals are spending the credit card issuer's money, but a debit card lets them spend money directly from your checking account.

With the credit card issuer's money on the line, there is time to report and manage the fraud before the bill comes due. If a debit card is used fraudulently, the funds are immediately debited from the linked account, and it could take weeks or months to have the money returned.

There's also the issue of the cardholder's liability under federal law. Traditional credit cards are protected by the Fair Credit Billing Act (FCBA) and includes limited consumer liability for fraudulent charges, such as:

• Liability of credit card users is limited to $50
• No responsibility for costs if the loss is reported before your card is used
• If only your credit card number is stolen, there's no liability for unauthorized use

However, debit card transactions fall under a different federal law called the Electronic Funds Transfer Act (EFTA), and the amount of liability varies. It isn't nearly as comprehensive as the consumer protections afforded by using a credit card, but you can expect:

• No obligation if your card is reported lost before unauthorized charges are made
• Liability for $50 when reporting the loss within 2 business days
• If reported more than 2 days but less than 60 days after the statement is sent, responsibility for $500
• Liability extends to all the money taken from your account if it's been more than 60 days after the statement is sent

You are afforded greater protection against liability for fraudulent charges if your answer to the "debit or credit" question is "credit". Visa and MasterCard offer zero liability policies that apply to signature-based credit transactions. However, neither MasterCard nor Visa provides zero liability for PIN-based debit transactions that aren't processed on their networks.

It's clear that debit cards lack many of the consumer liability protections when facing fraudulent charges that could initially go undetected. Bruchett warns, "Debit cards are linked to your bank account which no system is placed to monitor your transactions."

Final Thoughts

The next time a store clerk asks, "Debit or credit?", remember that choosing to process transactions as credit when making purchases with a debit card doesn't make it a credit purchase. The selection affects how the purchase is processed, and the better choice for greater consumer protection against fraud is to stick with using a traditional credit card.

Credit cards can be an effective way to manage money, improve credit, earn points, and travel with perks if used the right way. Benzinga's personal finance staff provides tips on using credit cards effectively. 

Related Links:

Despite A Strong Economy, Forced Credit Account Closures Are On The Rise

5 Tips For Dealing With Holiday Debt