Credit Demystified – Chapter 1, Section 2: Debit Cards

A debit card is just one of many ways of accessing money stored in your checking account.

Back in the day, people withdrew money from their checking accounts in one of two ways: they went to the bank and withdrew cash or they wrote a paper check. Then debit cards came along as an alternative to writing paper checks. Now, with technology, there seems no end to the ways we can access our checking account funds: online, mobile banking apps, and person-to-person [P2P] payment apps like Venmo, ApplePay, and CashApp to name a few.

The important point is that each of these methods of accessing checking account funds — withdrawing cash, writing a check, or using a debit card (whether directly or indirectly with a P2P app) — what you’re doing is taking money out of your checking account. You are directly accessing a finite amount of money. If your checking account balance is $500 and you spend $100 using any of the methods described above, you now have $400 in your checking account.

When you use your debit card, you are effectively signing a permission slip and giving it to your banker saying that you grant the merchant (store) permission to reach into your checking account and remove the amount of the sale. You gave the key and the combination to your bank account to the merchant and said, “I trust you to go into my money room and remove the amount we agreed I owe you.”

Now let’s be super clear here: there is nothing inherently wrong with using a debit card. The vast majority of the time this type of transaction goes off without a hitch. You pay, the merchant contacts your bank, the bank gives the merchant the requested money, and everything is hunky dory. You bought something without having the hassle of writing a check and the merchant made a sale and received payment without the hassle of dealing with your paper check. Everyone’s happy!

There are, however, a few important advantages and disadvantages to consider when making debit purchases:

Advantage

Debit cards offer one distinct advantage: avoiding debt.

Most bank accounts can be set up such that if you run out of money and don’t have the cash in the bank to cover a debit purchase, your purchase will be denied. No money, no spending.

Many people use debit cards as an external or extrinsic source of control over their spending. They use debit cards because they can’t or don’t trust themselves to limit their spending to the amount of money they have in their bank account.

This a valid tactic and I pass no judgement though I would argue that there are better ways of controlling your spending. [Unfortunately that topic is outside the scope of this guide but as a money coach I help clients use YNAB to ensure that every single one of their purchases — whether paid with cash or check or credit card — has the cash to back it up.]

Critically important caveat: it is possible to go into debt with a debit card. How? That’s covered in Section 1.4: Overdrafts & Overdraft Protection.

Disadvantages

Making purchases with a debit card has several distinct disadvantages.

1. As I described above, use of a debit card effectively grants someone permission to reach into your checking account and help themselves to your money. As a naturally suspicious person with control issues, that makes me a little uncomfortable. Does that mean merchants often try to pass through debits in the wrong amount? No. Definitely not. Merchants are more likely to charge the wrong amount at the register than they are to submit a fraudulent charge to your bank. But mistakes get made and things happen and my point here is debit charges allow direct access to your very real, and (I assume) very finite, checking account balance.
2. Your money leaves your possession almost immediately after you spend it. I know that makes logical sense and the natural question is, “Like, duh!?!,” but hold onto that thought because I’m going to propose an alternative a little later in Section 1.3 – Credit Cards.
3. Good luck renting a car or hotel room with a debit card. Nearly all rental car agencies, hotels, and other such merchants accept only credit cards. Essentially, any merchant providing a service with an open-ended final dollar amount will not accept debit cards because there is simply no way to ensure that your bank account will contain the necessary funds by the time the charge is finally processed.
4. As a corollary to the rental car/hotel room issue, sometimes merchants place a hold on a chunk of money in your checking account. Gas stations, for instance. If you scan your debit card at the gas pump, the merchant immediately puts a $50 hold on your account. This effectively freezes $50 of your available funds. You may pump only $10’s worth of gas but your bank will keep the other $40 frozen until the transaction has been processed and finalized. So if you’re down to your last $80 bucks and you desperately need gas and groceries, after the gas station freezes $50 you are left with only $30 available for groceries instead of the full $70 you actually have in your account.
5. Imagine, if you will, some dirtbag gets hold of your debit card or other means of accessing your checking account and goes on a spending spree. Let’s say they buy themselves a $1,500 flat screen TV. That $1,500 is gone from your checking account. That was probably your rent money, right? Or part of your tuition payment due in a week? But someone used your debit card and the merchant, having “your” permission, took $1,500 from your bank account. Ouch! So now you have to call the bank and convince them that you were in class in Denver at the time and date in question and not in a Walmart in Lubbock, TX, buying a $1,500 flat screen TV. And probably, eventually, you’ll convince a bank employee that it was a fraudulent charge and they’ll agree to return the funds to your account… sometime in the next 30 days!
   • Don’t believe me? A few years ago my daughter came home for Christmas. It was her first year after graduating from college and we were having a lovely time hanging out together in our PJs in the middle of the day watching a movie when her phone beeped. It was an alert text message from her bank regarding a large withdrawal. She immediately called the bank and assured them that she was indeed not shopping in Florida but in her parents’ living room in Colorado at the time of the purchase. It took about 25 days before the ~$800 was returned to her checking account. Could you easily absorb a temporary loan to your bank of $800 or $1,500?
6. My personal experience has been that banks are less vigilant than credit card companies about detecting potential fraud and shutting off the flow of funds at the first sign of suspicious activity. But my anecdotal evidence is backed up by industry rules and standards. In the case of lost or stolen cards, the rules are quite different depending on the type of account. With a missing or stolen debit card the maximum liability is $500. Yes, your bank can hold you responsible for the first $500 of fraudulent activity on your debit card. And that’s if you report the card missing or stolen within 48 hours of its disappearance. Once the 48-hour window closes, you are at your bank’s mercy as to how much, if anything, of your cash they choose to (eventually) reimburse. On the other hand, as long as you report a lost or stolen credit card in a “timely” manner, your maximum liability for fraudulent spending on that card is $50. [I’ve yet to meet anyone who was ever held responsible for any portion of fraudulent charges.]
7. Last, but definitely not least, using debit does nothing to build or improve your credit. [See Section 1.3 – Credit Cards and Section 3.3: Improving Your Credit Score for more information on building credit.]

To recap

Paying with a debit card is the same as giving each merchant permission to go into your bank account and take money. The money leaves your bank account almost immediately. If your card is used fraudulently, it is your responsibility to catch the fraud, report the fraud, prove it was fraud — and then you have to wait up to 30 days to get your money refunded back into your account. And debit card use does nothing to help build your credit. However, as long as your account preferences are set correctly, paying with a debit card will keep you from spending money you don’t actually have and thus help keep you from going into debt.

next >> Section 1.3: Credit Cards