Being Smart About How You Pay for Things Can Save You Thousands
Debit and credit cards look the same, they act the same, but they are very different.
I’m a financial advisor, and I see a lot of younger people just entering the “real world” who don’t quite grasp the difference between debit and credit cards. This is dangerous, and can get them into some financial difficulty.
I’m also old enough to remember “paper checks” — does anyone even remember those anymore? But young enough to have had debit cards as a way of life.
It’s critical to your financial health to understand the differences and use each type of card appropriately.
Debit Cards
Debit cards are boring. A debit card is an extension of your checking account. When you use your debit card to buy a $3 ice cream, the $3 immediately leaves your checking account and goes to the ice cream parlor.
When you use your debit card, it’s hard to get into trouble. You’re only able to spend as much as you have in your checking account.*
A debit card forces you to be responsible. If you only have $500 in your checking account, the debit card will only allow you to spend $500. So it’s hard to go into debt.
Credit Cards
Credit cards are the sexy cousin to the boring debit card. Credit cards are also linked to your checking account. But they only take money out of your checking account once a month.
A credit card doesn’t care how much money you have in your checking account. If you have $500 in your checking account, you can buy thousands of dollars worth of a stuff with your credit card. The credit card is fun and lives in the now #YOLO.
A couple weeks later, it’s now time to pay your credit card bill of $5,000. The only problem is that there’s only $500 in your checking account. No worries. The credit card is super chill about this kind of thing. He tells you, ‘Bro, I got you. You don’t need to pay me back right now. You can pay me back later. In the meantime, you just have to pay me some interest.’
Interest is a fancy word that means, I’m going to screw you. Credit card interest is very bad. Credit card interest is what makes people poor and keeps people poor. Credit cards tend to charge 20% interest. That means, if you owe them $5,000, you’ll be paying them $1,000/yr in interest!
This is the main reason I hate credit cards.
Now here’s why I like credit cards…
Credit cards help you build your credit. Having a good credit score will help you buy a house. If you use your credit card and pay off the entire balance every month, credit reporting agencies will take notice and acknowledge that you’re responsible and are good at paying people back. So when you need to borrow money for a house, lots of banks will be excited to loan you money.
If you use credit cards and pay off the entire balance every month, they can’t hurt you. They even help you by building your credit.
If you have $500 in your checking account, feel free to use your credit card to buy $499 worth of stuff. Then pay off your entire balance when the credit card bill arrives. This will build your credit.
In addition to building your credit, credit cards give you a tiny amount of rewards. The rewards are mediocre but still a nice little gift. If you spend $100 with your credit card, you’ll get around $1.50 back.
Unfortunately, most Americans are really bad at spending responsibly. Most people who use credit cards are not able to pay them off at the end of the month and they end up going into debt. If you’re like most Americans and not so great at budgeting, don’t use credit cards. Stick with debit cards. They’ll force you to behave responsibly.
Summary
Credit cards are awesome if you have your stuff together and spend less money than you make. They build up your credit and give you some small rewards.
Debit cards are awesome if you’re not so great with money / budgeting and tend to overspend. They force you to be responsible and keep you out of trouble.
*Some checking accounts allow you to ‘overdraft’. This allows you to take out more money than you actually have. This is bad. The bank will charge you high overdraft fees.
