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What are the differences between a credit card and a debit card?

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A debit card can be used at a retailer in a much the same manner as how a credit card is used.  However, there is a key difference between debit cards and credit cards. A debit card is issued by your bank as a means for you to conveniently access your savings or checking account.  When you use a debit card you are using the funds available in your savings or checking account to make a payment to the retailer. You can use your debit card only to the extent to which there are funds available in your account.  There is no line of credit involved in using a debit card. As it is linked to your bank’s savings or checking account, it is obvious that a debit card can be issued to you only by the bank with which you have a savings or checking account.  

A credit card on the other hands provides you with a line of credit (better known as the “credit limit”) to make purchases.  You do not need to have these funds available with you in your savings or checking account to make a purchase. Since credit cards are not linked to your savings or checking account they can issued to you by any bank irrespective of whether you have a banking relationship with them.  As you are not limited to only banks where you have an account, you can have multiple credit cards issued to you by various banks. In fact, in many developed economies the average credit cards per person is more than one and frequently 2-3 unlike debit cards.

In addition to the line of credit available, one of the main benefits of credit cards over debit cards is the opportunity for customers to earn reward points and cash back based on spends made on the credit card.  This allow customers to use credit cards to gain valuable rewards while going about their usual spending. However, if customers do not pay the total balances due on their credit card each month, then the interest levied on the outstanding balance can well exceed the rewards earned.

Debit cards have the advantage of course that you cannot spend more than what you can afford since you are only spending the money that is already available to you in your account.  This is viewed as a significant advantage for people who find it difficult to manage the urge to spend more than they can afford by using their credit card.

Debit cards and credit cards have similar levels of risk if they are lost or stolen and misused.  In both cases you will need to contact your bank as soon as you can to inform them of the theft or misuse.  Based on this information they will have the card blocked hence preventing any further misuse. Most banks have a specific length of time by which you need to report the card stolen or lost. Both debit cards and credit cards can be setup so you receive emails or SMS messages every time the card is used.  This can prove to be critical in identifying any misuse.

What are the advantages and disadvantages of using a Credit card?

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Credit cards are frequently accused of being stress inducing debt traps forced on gullible, unsuspecting customers!  However, if managed in the right manner, and as with many other financial products, a credit card can be a very useful and indeed profitable tool available to customers that can help them manage their personal finances more effectively.

What are the advantages of using a credit card?

Availability of short-term credit:

The main benefit of a credit card is that it provides you with the option of making a payment immediately without requiring you to have the money to pay for the purchase at the same time.  This gives you the flexibility of having access to a short-term loan whenever you require it. This is especially useful in situations such as a medical emergency or while travelling and so on.

Convenience:  

A credit card provides you the convenience of not having to carry cash with you to make the purchase.  This is especially helpful in situations where you need to make a large payment or spend time finding the nearest ATM!  Credit cards also provide you with the convenience of making payments without having to leave your home. You can use your card to make payments online, or even over the phone saving you a lot of time and effort of not having to travel to make the payment.

Credit cards can also be used to make recurring payments such as monthly school fee payments, insurance premium payments and so on.  This feature not only provides you the benefit of saving time by not having to travel to the school or insurance office every month but also saves you the trouble of having to remember to make the payments each month.  Just make sure your credit card has a sufficient available credit limit for the payment to go through!

Safety:

As credit cards give you the freedom to not carry around cash with you, this saves you from the risks involved in carrying cash including the risk of it being stolen, damaged, lost etc.  While the same could happen to your credit card as well, the risk is typically much lower as you can have your credit card blocked by just a phone call and also limit your liability of any misuse on the credit card.

Earn Rewards on your purchases:

Many credit cards offer Rewards for the purchases that you make on the credit card.  These rewards could be of various forms – “Air Miles” that can be used to pay for airline tickets, reward points for dining discounts that offer you discounts every time you use your credit card at a restaurant, shopping vouchers at specific malls or stores and many more.  The key point to note here is that you enjoy these additional perks just for using your credit card even if it is for your routine expenses. This is a significant benefit over using cash to make your payments.

Cash-Back Rewards:

Many credit cards offer you a direct cash-back against purchases you make. You receive a specific percentage of your purchase as “cash-back” through a credit in your credit card statement.  

The nature of these cash-back programs (and Rewards programs too) can vary significantly from bank to bank and a good understanding of these work will help you maximize the amount you can save by using the card.  A typical example is that most credit cards have specific categories of charges for which you can earn cash-back (groceries, school fees for example) and most will also have an upper cap on the amount up to which you can earn cash-back or even reward points.

Additional Benefits:

Almost all credit cards offer some form of additional benefits or “perks”.  These could vary from a whole host of benefits including: complimentary access to golf courses, free valet parking at busy malls, free cinema ticket offers, travel and medical insurance while travelling, free access to fitness centers, purchase protection and extended warranties on items that you purchase using your credit card and so on.

As you can see these additional benefits can vary significantly but most provide a significant tangible value to you as a customer if you can identify the credit card that is right for you and use it smartly.

Instant Access to Cash:

A credit card can also be a useful source of cash as most cards give you the benefit of withdrawing cash on the credit card against your credit limit using a regular ATM.  Although such cash withdrawals usually incur high fees and interest charges, they can be a useful alternative in case of an emergency.

Record Keeping:

Credit card statements can serve as a tracker for your expenses freeing you from the need to do this separately.  Some banks also provide you with a summary of your total spend.

What are the disadvantages of using a credit card?

Overuse:

The most significant disadvantage of a credit card is that it can potentially be used to make purchases beyond the customer’s ability to repay in full.  In such a scenario, by only paying a part of the total amount owed to the bank the customer incurs interest charges on the outstanding amount carried forward.  Credit card interest rates are amongst the highest in any financial product and carrying forward a balance outstanding and paying interest over a long period of time can be a drain on a person’s financial resources.  

While credit cards provide us with the flexibility of making purchases without the need for cash, if used excessively and with no ability to repay the amount quickly they can very easily result in the customer falling in to what is known as the “credit card debt trap”.  It can be very tempting to use your card to buy your loved one that perfect gift, or treat your family to a great vacation, or buy the latest electronic gadget available but when there is no clear plan on how soon you can repay these amounts, it is very likely that you will end up incurring large interest charges which will continue to build up until you pay the total amount outstanding in full.  However, just like any other financial tools, if used smartly credit cards can provide a range of benefits to the user both tangible (reward points and cash back amounts earned back based on spend) and intangible (convenience, security, safety etc.).

Misuse if stolen:

You could potentially be liable for amounts used on your credit card after it is stolen.  However, with improvements in technology such as PIN based transactions, instant SMS and email alerts on all purchases, and also password-based access controls for online usage it is possible to prevent and limit such unauthorized expenditure on your card.  Having said that, thieves and hackers are also always trying to keep up with the latest technologies and it is always most advisable to be aware of and follow all instructions advised by your bank to help safeguard your credit card details and usage.

Hidden Charges:

Credit cards have many varying kinds of charges that can vary depending on a lot of factors.  The most commonly known charge is the Annual Membership Fee (AMF) which is a yearly fee charged by the bank for use of the card.  Not all credit cards have this charge though and almost all banks offer some credit cards which do not have an annual fee. Also, many banks will have a program to waive your annual fees depending on how much you spend on the card during the year and how well your repayment history has been. You could also request your bank to review your card history and provide a waiver on the annual fee if your card performance history has been good.  Please do realize however that it is up to the bank’s sole discretion to waive any fees for you!

However, there are several other types of charges such as late payment charges, over limit charges, cash advance charges, supplementary card charges and so on.  It is very important to have a sound understanding of what charges your credit card carries and clarify any questions with the bank in case you are not sure of what a particular charge is levied for.

How does a credit card work?

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Banks & financial institutions that issue credit cards do so based on a review of applications submitted by customers which include among other things personal information such as contact information (phone numbers, home and work addresses etc.), employment information (name of employer, income, years in the current job, overall employment experience etc.) and so on.

If the customer is approved by the bank to be issued a credit card, the card is processed and physically delivered to the customer (except in the case of electronic-only credit cards).  The customer is assigned a credit limit which is the maximum amount up to which he or she can use the credit card to make purchases before they need to make repayments to the bank.

When the customer uses his or her credit card to make a purchase at a retail store or hotel or any “merchant” that accepts credit cards, the particular amount in blocked from their total credit limit and they can then only utilize the remaining amount available to make further purchases (until they make payments to the bank).  The bank makes the payment on behalf of the customer to the retail store and provides the customer a credit-free period (usually between 30 to 60 days) after which the customer needs to repay the bank for the purchases made.

At the end of the credit-free period the customer is provided the option of either paying up the entire amount which has been utilized by them or a certain percentage of the amount (usually as low as 5%).  If the customer makes a payment for the total amount that was due then they do not owe the bank any interest charges and they have enjoyed the benefit of an interest-free credit period from the bank. If, however, the customer choses the option of making a payment less than the total amount due then interest charges will be levied by the bank and these amounts will also need to be paid along with the remaining amount of purchases still unpaid.

What is a Credit Card?

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Credit cards are a form of lending offered by banks and financial companies to provide customers the option of purchasing goods and services on credit as an alternative to paying for those goods or services by cash.  It can be thought of as a recurring short-term loan that is provided by the bank (or financial institution) to the customer to help him or her make a purchase without having to pay for that at the time of making the purchase.  A credit card basically provides you with a line of credit with the bank or financial institution issuing the credit card.

While there are several benefits of using a credit card, the primary benefit is that the customer can make a purchase without using cash and repay the amount after a period of time, also known as the “credit-free” period which is usually anywhere between 30 and 60 days.  

For this service provided to customers, banks and financial institutions charge a certain % of interest and/or fees.  However, credit cards can also be used in a manner that does not incur any interest charges.

While the most popular form of a credit card is a plastic card issued to the customer, there are also instances where the credit card issued is only a number which the customer can use for making online purchases.