Understanding the Pros and Cons and Finding the Right Card for You
A very long time ago, I wrote an extremely brief article covering the difference between charge cards and credit cards. That article really didn’t answer the question, though, because I still have conversations and receive emails where people use the phrases “charge card” and “credit card” interchangeably.
Along those same lines, Tim writes in recently:
Am I better off using a charge card or a credit card for buying stuff?
At first, I just assumed that Tim had replaced “credit card” with “charge card” in his vocabulary and I began to answer that question, but then I realized that it’s worthwhile to distinguish between all three types of cards and their advantages and disadvantages. So let’s go through them one by one.
A credit card is borrowed money. When a company issues you a credit card, you’re given a specific credit limit – the maximum amount you can borrow from the company. Each time you use the card, you borrow some amount from that company, and each month, you’re required to pay back a portion of that amount to the company. Mastercard, Visa, and Discover are the major types of credit cards.
The biggest advantage of a credit card is the flexibility. You can make purchases without actually having the cash on hand at the moment. You also have an indefinite amount of time to pay back that money, though you do have to make a minimum payment each month on what you owe. Many credit cards also have rewards programs, which return to you 2-3% of your purchase price in some form or another – often in the form of gift certificates or rewards programs. Also, good credit card use helps you to build a good credit report, which can save you money on insurance and help you with loans. Consumer protection with credit cards is usually pretty strong, too – they’ll often help you deal with fraudulent purchases and don’t leave you out to dry if you lose the card.
The big disadvantage is that all the flexibility is a double-edged sword. The ease of use of credit cards and the lack of pressure to pay off what you owe makes it very easy to make poor purchasing decisions. Then, when you can’t pay off the card, you usually pay a hefty amount of interest on that unpaid amount – and over a long period, that interest can be incredibly costly.
A debit card, on the other hand, is linked to your checking or savings account. Each time you use the card, money is automatically taken from your checking or savings account to cover the purchase. Many debit cards have the same purchasing flexibility as credit cards, as many are accepted where Visa and Mastercard are.
You can’t get into debt trouble with a debit card. It does not allow you to buy things that you don’t have the money for. For people struggling with debt, this is a huge advantage because it keeps you out of trouble. Plus, they’re flexible and convenient for day-to-day purchases. You also don’t have to have good credit to get a debit card – you often get one with your checking account.
The biggest disadvantage is that you have to keep a very close eye on your account balances, because you can overdraft your account if you’re not careful. Another disadvantage is that very few debit cards have rewards programs of any kind. Debit cards often don’t have the same consumer protections that credit cards and charge cards have – if your card is stolen, your protection against unauthorized purchases can be weak.
Charge cards are often confused with credit cards, but they actually function in a fairly different fashion. Like credit cards, charge cards extend credit to you from the issuer, but you’re required to pay the full balance at the end of the month. Some charge cards also have an annual membership fee. Charge cards are typically associated with American Express; many store chains often issue their own charge cards as well which can only be used at that store.
You don’t have to have the money on hand for a purchase with a charge card, nor do you run the risk of carrying a balance that will charge you interest. Many charge cards have tremendous bonus programs that go from things like 5% cash back to free companion flights on airlines – their bonus programs are typically better than bonus programs for credit cards. Charge cards often come with additional services and benefits, like free roadside assistance, free food at airports, and free hotel room upgrades. They also help your credit much as a credit card does. Most charge cards offer strong consumer protection as well, similar to that of credit cards.
Some charge cards have an annual fee which eats away at the benefits from using it. Also, since you are operating on credit, there is some risk that you might build up a large balance on the card that will be difficult to pay off. Many charge cards are usually pretty strict in terms of who they’re issued to – you need to have good credit before even getting one.
Which One Is Right For Me?
Many people wish to avoid credit at all costs because of the risk of debt – in that case, a debit card is obviously the right choice. If you’re seeing a great debit card (preferably one that has some semblance of a rewards program), you should investigate all of the checking options available at your local bank and also perhaps do some shopping for a new bank, particularly if you’re unhappy with your current bank for some reason.
I tend to believe that it’s worthwhile for everyone to apply for at least a single credit card and use it irregularly. It provides a very easy way to build a positive credit report and gives you some flexibility in purchasing. If you have a good rewards card (for example, I use my Citi Driver’s Edge card for all gas purchases), you can also earn multiple percentage points back in rewards.
If you have excellent credit, have a strong policy of paying your balances back in full each month on your credit card, and travel a bit, it’s worth examining some of the charge card offers available to you, particularly if you’re running a small business. Typically, one can get a big net benefit from a good charge card, but you have to be aware of the benefits alloted to you by that card. Plus, you can’t get into revolving debt trouble with a charge card since you have to pay the balance in full each month. I know at least one small business owner who makes a killing with his charge card, getting tons of free flights, free airport foods, discounts on rental cars, roadside assistance, free hotel rooms, business advice, and so on, but those are rewards that others may have difficulty maximizing.
My suggestion, if you’ve never owned a card, is to get a good checking account (I use Capital One 360 as my primary checking and I’m happy with them) and use their debit card for most purchases. At the same time, get a credit card, use it for only a few purchases, and leave the card at home so you’re not tempted to use it. This allows you to start building healthy credit without the debt risks of a credit card.
Please, readers, fill in additional details you see as important – many more people than just Tim will find use with this information.