Credit Card Versus Debit Card
Credit cards and debit cards offer an unprecedented level of convenience when it comes to shopping and purchasing goods or services. Using a credit or debit card is much faster and also safer than handling cash. In addition, unlike when someone writes a check to make a purchase, merchants can always be assured that the funds are available. It is, however, important to understand the difference between how credit cards and debit cards work. While they are similar in many ways, they are also quite different, and there are unique types of risks that are associated with their use.
How Credit Works
Credit is a form of debt, or borrowing, that involves making purchases of either products or services with the assurance that the buyer will pay for them in the future. A credit card is an example of revolving credit, with which buyers have a maximum limit of debt that they can accumulate. Every month, this debt, or balance, requires a minimum payment that the consumer must make, and the unpaid debt is kept, or revolved, as a remaining balance. Payments on these balances typically carry an additional charge known as an interest rate. There are also credit cards that represent a type of open credit. Credit cards based on open credit must be paid off in their entirety every month.
A credit score is a calculated level of confidence that financial institutions have in a borrower's ability to pay back their debts. It is a numerical figure that results from analyzing a person's payment history, among other factors. The higher the score is, the more favorable the person's credit rating is. A more favorable credit rating means the borrower can enjoy higher borrowing limits and lower interest rates. A bad credit rating, on the other hand, will hinder a person's ability to get credit or otherwise borrow money. For example, a person with poor credit will have difficulty getting a home loan, and in many states, it may even result in higher auto insurance premiums.
The modern system of credit began just before the turn of the 20th century when merchants started sharing data about customers who made purchases with credit. One of the first companies dedicated to recording information about borrowers was the Retail Credit Company, which was founded in 1899 and later became known as Equifax. A large number of credit bureaus appeared during that time, and they became controversial due to a lack of transparency and other issues. As a result, the Fair Credit Reporting Act (FCRA) was passed in 1971 to regulate these companies. Consumers, however, did not get reliable access to their credit scores until the FCRA was updated in 2001.
Advantages and Disadvantages of Credit Cards
Credit cards are useful for when a buyer does not have cash on hand but will have it in the future. This is because the purpose of a credit card is to defer payments on purchases until a later time. Credit cards typically come with a 16-digit account number printed on their face, and customers usually have to sign a receipt that accompanies their purchase. This signature is intended to provide security against fraud. In some cases, signatures may not be required for purchases with small dollar amounts.
Credit cards can be used to build up a positive credit history and raise a borrower's credit rating if they consistently make timely payments. Credit cards typically have purchase protections that enable the credit card owner to rescind payments in cases of fraud or disputes with a merchant. On the other hand, a credit card purchase raises the balance of the account, which adds to the consumer's level of debt. Credit cards can also tempt consumers to make impulse purchases that they normally wouldn't make. This can easily put a card owner into a high amount of debt. Credit cards also carry interest that makes it harder to pay down the balance.
Advantages and Disadvantages of Debit Cards
Debit cards enable purchases based on the amount of cash in a person's bank account. Purchases made with debit cards typically must be activated by the use of a PIN, which authenticates the card holder and helps to fight fraud. It is called a debit card because each purchase is a debit against, or reduction of, the funds available in the user's bank account. Debit cards can enable a user to get cash back from automatic teller machines (ATMs) so they can pay for something in cash, too. Debit cards are limited by the money in one's bank account, so purchases made with them do not count toward any debt balance. The disadvantage of this is that if a buyer makes a purchase that brings their bank account balance below zero, it can result in an expensive overdraft charge. Debit card purchases are usually not protected against fraud or disputed purchases, although in many cases modern debit cards are hybrid cards, or cards backed by credit card labels such as Visa or MasterCard. Hybrid cards will have the same purchase protection as credit cards.
ATMs are automated devices that enable a customer to interact with their financial institution without the need to wait in a bank line to speak to a customer service representative, or teller. Some ATMs work with debit cards or credit cards or both. They typically work by reading a magnetic strip on the back of a credit or debit card or an ATM card and then asking for a PIN to access the account associated with the card. Upon gaining access to the account, a customer can perform a variety of automated financial transactions. This includes showing account balances, withdrawing cash, or depositing funds in various forms, such as cash or a check.
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