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Debit or credit: Weighing the financial risks

A generation’s worth of warnings against piling up consumer debt have finally found an audience, using debit cards to the near-exclusion of credit cards, though fiscally sound, is not without risk. By Gayle B. Ronan.
A sample credit card with "blink" technology is swiped across a reader at a fast food restaurant in Denver recently. Whether you use a credit or debit card to make everyday purchases, be aware of the risks and costs associated with each type of payment, experts say.David Zalubowski / AP file
/ Source: contributor

With plastic displacing currency, the question of ‘cash or credit’ is fast becoming one of ‘debit or credit.’ The choice often betrays a purchaser’s age along with a potentially false sense of security.

For Chicagoan Katie Smith, a 25 year-old claims analyst, the choice is clear, “I prefer using my debit card because I’m spending money I have. I don’t trust myself to pay my credit card charges off each month.” 

Smith is far from alone.

“Among my friends, credit cards carry a stigma.  Even if we have them, we’re hesitant to use them,” says Erin Green, also 25, and a public relations specialist in Chicago.  The stigma has everything to do with debt. “We’ve heard too many stories about how credit cards lead to financial trouble,” adds Green, who only charges significant purchases, like furniture.

“It is a mindset of the demographic,” confirms Alan Schultheis, director of Edgar, Dunn & Company, a consultant to the payment and financial services industries. “Younger adults fear losing financial control. They are shunning credit in favor of the discipline offered by debit cards.” 

While a generation’s worth of warnings against piling up consumer debt have finally found an audience, using debit cards to the near-exclusion of credit cards, though fiscally sound, is not without risk.

Debit card debt?
“It is still possible to run up debt on a debit card,” warns Jean Ann Fox, director of consumer protection for the Consumer Federation of America.  She says some banks process debit card charges despite insufficient account balances, creating credit transactions. Cardholders are typically caught by surprise since according to Fox, there are no laws requiring prior approval or even disclosure of this option, which undermines the sense of fiscal security favored by debit card users. The first clue of overspending, an errant deposit or fraudulent charges is typically the accumulation of overdraft charges — upwards of $30 for every transaction that occurs while the account is overdrawn. 

Because some debit charges do not occur in real-time, especially those that were signed for (versus entered with a personal identification number or PIN), “it can be days and hundreds of dollars in fees, before an unintended overdraft loan is detected,” says Fox, whose son recently learned this the hard way while traveling. “If consumers always carry excess balances, track those balances constantly, reconcile statements and of course never lose their cards, then there is no risk to using a debit card,” she adds.

Losing a card or card number either by accident or through fraud can also have different implications for credit and debit card users.

“Basically there is no risk to using a credit card,” says Schultheis. Federal consumer protection law limits the liability to $50. “Few issuers even impose the $50,” he adds.

Under the same scenario, many debit card issuers also assume the liability, but with qualifications. “Card companies advertise zero liability. But read the fine print,” advises Fox.  Generally, the issuer requires notification within 48 hours of the occurrence. That window can close before a cardholder ever realizes there is a problem.

Even if cardholders make the deadline, they may be out of luck. While Visa says all signed purchases are treated just like credit card purchases and covered by zero liability and dispute resolution — including the online and telephone purchases experts advise against ever making with a debit card to begin with — PIN-based transactions processed through non-Visa networks may not qualify for the same treatment.

Even so, as long as fraudulent charges are reported within sixty days, the cardholder’s liability is capped at $500 — a rather large sum for a young adult. In the interim, the account will still be out the money.

“Also they lack the right of charge-backs, unlike credit cards,” says Fox. With a credit card, consumers can refuse to pay questionable charges, which are removed from their accounts while in dispute.  With a debit card, the money is already out of the account.  “It is up to the consumer to get it back — shifting the balance of power,” adds Fox, who likens debit cards to walking around with a pocket full of endorsed blank checks.

Recently Europe and Canada moved toward PIN-only systems for their debit card transactions. The general feeling is fraud will be significantly reduced due to the way transactions are processed there. They are also embedding computer chips in their cards for further security.

For Americans whose debit cards carry either a Visa or MasterCard imprint, transacting abroad should not be a problem.  According to Visa, the terminals can accommodate these US-issued cards. But holders of non-Visa or MasterCard-branded debit cards are advised to call their banks before leaving home. There is a good chance their cards will not work abroad.

Visa also suggests all cardholders notify their banks whenever traveling abroad. Many banks use fraud-prevention software that automatically freezes accounts when debt transactions made from foreign countries are detected. 

While Robert Pagliarini CFP, an executive vice president with Allied Consulting Group, a financial advisory firm in Los Angeles, heartily endorses the fiscal restraint required by debit cards, he acknowledges they have their disadvantages: “Some debit card issuers only allow a fixed number of uses each month.  After that, they charge fees.  Many enforce maximum daily spending limits, creating a problem while shopping [for large ticket items or during the holidays]. Then there are the ATM fees,” says Pagliarini. 

But his biggest concern is for younger clients favoring debit rather than credit cards. He thinks they are missing an opportunity to establish their creditworthiness. “With credit cards they can build their credit scores,” says Pagliarini.  “That is something they should be doing — creating a track record of responsibly managing credit.  It helps reduce the rates they will pay later when they apply for car loans and mortgages.”

Additionally, he explains, no-fee credit cards when used with discipline are basically free, thirty-day loans. They allow users to hold onto money longer while earning interest on balances before paying bills. “Also,” observes, Pagliarini, “Many cards carry extras, like rewards programs and extended warranties on purchases, along with car rental insurance coverage, which most debit cardholders forgo.” 

Bottom line: When used responsibly, credit cards offer the better financial deal and are not as "risky" if they are misused.  Debit cards, on the other hand, force their users to spend responsibly, but are too frequently embraced without thought to their underlying costs or risks.