Credit Cards vs. Debit Cards – A Different Take

Kevin M

I hate this topic—so why am I writing about it? Because it seems to be a staple topic of the personal finance blogosphere! And almost universally, the conclusion will inevitably come down on the side credit cards as the better deal.

Warning: if you’re looking for that same conclusion here, you’ll be disappointed. Being contrarian by nature, here’s my take on the debate.

I think debit cards are the lesser of the two evils mostly because there’s little chance with a debit card that you’ll end up paying for this months expenses next month, next year or over the next 10 years. That ices it for me, but we can go on.

We can get into the mechanics of which costs more or has better benefits, but those are details that ignore the most important element–the human factor. If we’re all trying to get out and stay out of debt, spending with a credit card is a contradiction in terms.

Worse, for those who have dug themselves out of a debt hole and think that credit cards are now your friend, just remember that like an alcoholic, you aren’t cured, you’re just recovering. Why play around with credit cards when you got into trouble with them in the past?

The typical pro-credit card arguments

We’ve probably all read or heard these ad nauseam, but in the interest of balance, let’s do a quick recap:

1. Buyer protection
2. Rewards programs
3. Identity theft (quicker reaction time than debit cards)
4. Credit score enhancement
5. No overdraft fees
6. ”I pay off my balance every month; I know how to manage money”

I’m not going to lie, there’s at least some merit to each of these, just not enough to swing the balance in favor of credit cards. A closer consideration of each is in order.

Buyer protection. A neat benefit to be sure, but in my opinion, one which is more than offset by credit card gooble-dee-gook. Have you ever read a credit card contract? Read it sometime and then tell me that the once or twice in a decade that you’ll need buyer protection will be worth the risk you’re taking on by dealing with the card issuer. They have all the rights, and can change the rules at any time without your consent. Your only real option is to payoff your balance, close your account and seek a new issuer who will play more fairly. That’s an unequal relationship, and those are best avoided.

Rewards programs. In the past couple of years, many credit card issuers have either scaled back or completely eliminated their rewards programs. In addition, card issuers don’t provide these rebates out of the goodness of their hearts; they’re doing it because a reward for spending will generate more spending! This is hardly what you need to be doing if you’re trying to get the upper hand on your finances.

Credit card companies collect money from both sides of a transaction, from you the borrower, in the form of interest and fees, and from transaction fees charged to the merchant. The more you spend the more they make. They’re betting that human nature, coupled with a generous credit limit and a reward for spending will overwhelm your will to resist splurging. Are you willing to bet yourself against that arrangement? Remember the credit card companies have willing allies in the advertising culture who are working 24/7 to get you to buy what they’re peddling—even if you don’t need it. No plan can save you money by getting you to spend more money.

I don’t know about you, but I’m fully prepared to leave a few nickels and dimes on the table in favor of not spending my dollars.

Identity theft protection. With identity theft credit cards do offer better protection than debit cards, in that they’ll cover the cost of fraudulent charges almost immediately. Score one in the definite win column for credit cards on this one. But identity theft risk can also be reduced on debit cards by maintaining a balance that closely matches your expected spending. The thief can’t access more money than you have in the account. In addition, a Paypal account linked to your checking account can provide a secure way to make online purchases, one of the major areas of identity theft concern—and it costs nothing to add this feature. It’s also worth noting that the biggest concern with identity theft is not necessarily the thief’s access to a single account, but to the information linked to that account—a much bigger prize. On that count, credit and debit cards are an equal risk.

Credit score enhancement. This is the most tiring pro-credit card argument of all. In order to keep your credit score high, you need to maintain high credit lines with low outstanding loan balances—the credit utilization component of credit scores. While there’s truth to this assertion, it ignores the fact that credit utilization is only one component of your overall credit score. Paying your bills on time alone carries more weight, and so do pay histories on mortgages and installment loans. Other factors include the age of loan accounts and number of credit inquiries. I have better things to do with my time than to perpetually track my credit scores to determine that I have the proper balance of outstanding debt to available credit. If our plan ultimately is financial independence, our primary goal should be to stay out of debt, not to invest time figuring out how we can juice our credit scores. You mostly need high credit scores to obtain credit; the less dependent we are on credit, the less important our credit scores are.

No overdraft fees. Really? Ever hear of over-limit fees? They’re overdraft fees for credit cards. There will be a penalty for exceeding certain balances whether we’re talking debit or credit cards.

”I pay off my balance every month; I know how to manage money.” Congratulations, but you’re still playing with fire. Credit cards are set up to keep you in debt, not to help you manage your finances. Become too comfortable with them and you may be stepping into a trap you don’t fully understand. Today you’re managing your finances successfully, but in the future you could find yourself in a period of extended unemployment, and the balance may shift. When crisis hits, we tend to cling to what’s familiar; credit cards may prove to be a bad habit at that point.

The strongest arguments against credit cards

OK, so we’re in a credit crisis, one that by all accounts looks as if it will be with us for some time as the various components shake out the excess and bad debt. Logically it seems the last thing the average person needs is more credit. As citizens and consumers, the best thing we can do for ourselves and for the country—long term—will be to live without credit.

The Bible refers to debt as bondage, that the debtor is the slave of the lender (Proverbs 22:7)—does anyone disagree with that connection?

It seems to me that the goal of most all who seek to improve their lot in life would ultimately be the complete elimination of all debt, with credit cards at the top of the list. Why play with a convenience that has the easy potential to put you deep in a debt hole should the wrong combination of circumstances line up?

If you’re a recovering debt junkie, you don’t need to be carrying credit cards in your wallet. Would you advise a recovering alcoholic to get a night job as a bartender?

Finally, I like simplicity, and find it one of life’s more pleasurable traveling companions. If cash is the simplest medium of exchange, debit cards are the next best thing.

Credit cards mean complex contracts, interest rates, debt hangovers, potential spending binges and changes in terms at inconvenient times. You have none of that with debit cards. And even if you choose to handle most transactions by credit card, you’ll still need to have at least one checking account, most likely with an attendant debit card that you’ll use at a minimum for ATM withdrawals. Translation: multiple accounts.

Now none of this means that I think we should all go without credit cards. But there needs to be a hierarchy–with credit cards at the bottom. Cash for small purchases (reduces bookkeeping and activity fees on debit cards), debit cards for most other purchases, and credit cards for those rare situations where their benefits will provide the greatest advantage. Keep a credit card for those times when you specifically need buyer protection, or for the purchase of airline tickets if your card provides travel insurance at no extra cost. Keep the card out of site the rest of the time, which will cut down considerably on the possibility of running up a balance you can’t afford to pay off immediately.

My vote is for debit cards; what’s yours?

Tags: credit cards, debit cards, money management