As technology evolves, so does our understanding of and relationship with money. Gone are the days when we carried bank notes or cash. Bank cards — in the form of credit and debit cards — have become the norm. The move to a cashless society was especially exacerbated by the COVID-19 pandemic since cards offered more convenient and touchless options — using tap — to make payments. One thing is certain, credit and debit cards have overtaken cash and are poised to remain the dominant means of payment for the years ahead.
To better navigate all the layers associated with money management, a thorough understanding of the terminology, technologies, and usage habits is essential. In doing so, you can boost your and your family’s financial literacy skills. The earlier you learn, the more likely you are to make smart money decisions. It is crucial for kids and young adults to understand how they are using their funds and cards so that they can transition into responsible and financially savvy adults.
Since bank cards have mostly replaced cash, understanding how those cards are one of the primary steps toward financial literacy.
Difference Between Debit and Credit Cards
To help understand the differences between both types of cards, here’s a quick summary:
- A debit card is a plastic bank card that is issued by your bank and is directly tied to your chequing and/or savings bank account. It may be used to make in-store purchases and cash withdrawals at ATM machines. Using a debit card will automatically deduct the sum of a purchase from the associated account without incurring any extra charges.
- A credit card is also issued by your bank, but often on behalf of the credit card company. Credit is a form of a loan and credit cards are bound by credit limits (i.e., the maximum amount that you may use). Customers receive their credit card statements each month and expected to either pay their full balance amount or a monthly fee that is often calculated by the bank to minimize their debt amount and remain in good credit standing.
While credit cards and debit cards look very similar at first glance. However, both types of accounts operate in a very different manner. It is highly important to know the differences as a key component of financial literacy and money management. Incapacity to clearly grasp those distinctions may lead to misuse, missed payments, and big trouble.
In 2019, consumer credit report agency Equifax estimates that the average amount of non-mortgage (credit cards, lines of credit and car loans, etc.) to $23,800. And that is before COVID-19, whereby in 2021, 14% of Canadians have enrolled in new credit products and have taken on more debt to brace for the effects of the pandemic.
It is vitally important to understand different types of cards and associated accounts for financial security.
5 Factors When Choosing Between Credit or Debit Cards
- Monthly Fees and Annual Fees: Accounts associated with debit cards have monthly fees that are automatically deducted from your bank account. These fees are fixed. This means that they do not change if the money your bank accounts is more or less than the previous months’. Fees and charges with credit cards are much more complicated and payments might differ drastically from month to month based on recent purchases. Additionally, they are directly correlated to the balance that you owe on your credit card. The higher your balance on your credit card, the more you will end up paying every month. Moreover, these fees include a pre-set interest rate, monthly usage fees, extra charges for any missed or late payments, and many other hidden fees that are difficult to make out without looking closely at monthly statements to examine any potential red flags.
- ATM Fees and Cash Withdrawal Fees: Depending on the agreement that you have with your bank, you would either have an unlimited number of cash withdrawals at no cost or a set number per month, after which the bank may charge for every extra withdrawal. It is important to stick to your bank’s ATM machine; using another bank machine or a convenience store machine means that you might be charged a fee by both, the bank and third-party vendor (ATM). Credit cards, on the other hand, mostly charge a set fee every time you withdraw money from your credit card – interest rates on cash withdrawals are often higher than on purchases, so it is best to conduct cash withdrawals from your debit card and your bank’s ATM machine to save on those costs.
- Points and Rewards: While credit cards may be notorious for their hidden fees and deceptive charges, one area where they do stand out is in the many rewards and benefits offered with purchases. Users can collect points and miles towards their next vacation, take advantage of discounts available to them through their credit card, and even gain receive cashback incentives by using their credit card. The key is to pay as much off as soon as possible, while also enjoying all the perks that credit cards offer. Debit cards, on the other hand, do not provide the same time of benefits with usage.
- Building a Credit Score: All Canadian adults have their credit history tracked and saved by financial institutions and credit agencies and are assigned a credit score. This comes in very handy when asking for a large loan to either purchase a car or apply for a home mortgage. Service providers will look at your credit score and determine how likely you are to pay back the loan and at what interest way. The best way to build one’s credit is through the responsible use of credit cards over time. Unfortunately, activity on your debit card will not count towards your credit rating since it is technically not credit and is money spent from your income and savings.
- Ease of Use and Convenience: Both types of cards are easy to use and an overwhelming majority of retail outlets and service providers in Canada accept both, debit, and credit cards. Debit cards, however, are even more widely accepted than credit cards Merchants and service providers prefer debit cards to cash because the transaction is instantly debited from the customer’s account into the vendors. With credit cards, some transactions might take a longer time to process and could be rejected later on if the customer has reached their credit card limit, making it necessary for merchants to spend time on coordination with their banks. On the other hand, credit cards are the preferred method of payment among merchants because transactions made by credit cards are more easily traced than those done by debit cards. In sum, debit cards are perceived as less risky by merchants and are accepted at more point of sales machines than credit cards are.
Prepaid Debit Cards: An Alternative, Convenient and Less Risky 2-in-1 Solution
A prepaid debit card shares commonalities with both but also works in a similar way to a gift card.
For those who do not have access to either a debit or a credit card, a prepaid debit card works wonders. It is particularly useful in teaching kids and teenagers money management skills and within pre-set budgets.
The way a prepaid debit card works is by creating an account for the card with the service provider. The user (or user’s parents) can load money onto the card directly from their bank accounts, and the user can make purchases with the card virtually anywhere – in-store, online, and for cash withdrawals.
Unlike regular debit cards, prepaid debit cards allow users more options for online purchases. Moreover, all prepaid debit cards are bound by the amount deposited onto the card, so purchases do not face the risk of racking up debt like they would with a credit card.
A few consumers are categorically against the concept of debt, whereas many Canadians use both, debit, and credit cards interchangeably or depending on their needs. Say, for example, you are a young Canadian who is in university and working part-time. You would mostly use your debit card for day-to-day purchases as it offers the most convenience and does not come with the same risks as borrowing money does. Still, you can also occasionally use your credit card for bigger purchases to collect rewards and build credit history over time. The rule of thumb, however, is to pay off any outstanding debt as often as possible. For those who want to have the best of both worlds, a prepaid debit card would come in handy, since they come with the convenience of both, but without the need for an actual bank account and free from the risks that credit card misuse can have on debt levels and credit scores.