As featured in the Finances FYI section of the the Seattle Times
By 1st Security Bank
Entering the world of personal finance can be overwhelming, and a basic understanding of terms is critical to your financial well-being.
Credit or debit, two of the most fundamental terms related to spending, can often be confusing if you don’t know the differences. Whether you’re just starting to think about your money in the long term or simply need a refresher on best practices, it’s helpful to know what each means, when to use them and how to make each work for you.
The differences between credit and debit
Both methods are used to make purchases without checks or cash, but differ in their source of funds. Credit cards are essentially a line of credit — or loan — from the credit card company at purchase time. They’re paying for whatever product or service you’re using, and you’re entering an agreement to pay them back within a specified time, often with interest. Instead of requiring a PIN for purchases, credit cards typically only require a signature.
On the other hand, debit cards are taking funds directly from your bank account at the time of purchase. These transactions occur in real time, and after swiping your card, you’re finished with the purchase process. These purchases are interest-free — and sometimes, your savings or checking account will be interest bearing, earning you money as you save.
What’s the deal with interest?
Interest payments are the key to deciding whether to use credit or debit. Most credit card companies charge interest on an account if the balance is not paid in full within 30 days. If you’re able to pay your balances quickly, credit can be a great way to increase your spending power.
Depositing money in interest-bearing savings or checking accounts is the fastest way to put your money to work for you. Instead of paying interest on previous purchases, you could be earning money on the funds in your account. Most of these accounts can be linked to a debit card, providing you unique advantages over credit.
Advantages to each
Both spending methods have advantages that make one more useful than the other in certain situations. Knowing these differences is essential to maintaining financial health, and you should consider them before any purchases.
Credit. Despite potential interest payments, there are several reasons you may want to use a credit card for your purchases. Perhaps the most significant benefit is time. Most purchases won’t have to be paid off for at least 30 days, and that extra window can be enormous in times of emergency. Using credit will also help establish your credit history, increasing your future borrowing power and opening up new investment opportunities.
Debit. The most significant advantage of using debit accounts is to limit the accumulation of debt. If you’re only spending money that’s already in your account, you aren’t accruing any debt and will maintain financial independence. While some debt is beneficial to increase your creditworthiness, it’s essential to not spend over your head, and using debit is the easiest way to stay within your limits. Debit accounts can be used to access cash quickly and penalty-free, making them one of the most convenient ways to access your money.
Credit and debit accounts should never be viewed as one or the other when focusing on your savings. When used properly, the two should work in harmony to help you maximize your spending power and achieve your financial goals. Credit cards are essential in building your credit rating and are invaluable in times of crisis. Debit cards should be your daily go-to, taking funds directly from your bank account to make purchases without accumulating debt.
The more you educate yourself about the financial world, the more you’ll find success along your financial journey.