Debit cards have become one of the most common financial instruments. Unfortunately they are also one of the most misunderstood financial tools. Every consumer should have an understanding of what debit cards are and how they work.
There are also many myths about debit cards that get consumers into trouble. Knowing exactly what a debit card is and how it works can save a consumer a lot of money.
Debit Card Basics
A debit card is a plastic card that functions like a credit card. The card contains a magnetic stripe that carries banking information in the form of an electronic code. When swiped through a card reader this code gives a computer the information it needs to contact your bank’s computer via the internet. The computer can check to see if funds are available and transfer to another account via electronic funds transfer or EFT.
Another method is to type in the card number which also allows access to your bank account. The card number functions just like the account and routing number on a check. It authorizes somebody to transfer funds out of your account. In many cases a card user will have to enter a security called a pin or personal identification number to authorize a transaction.
Debit Card vs. Credit Card
The difference between a debit card and a credit card is that a debit card only authorizes somebody to take funds out of an account. Contrary to popular belief this can be a checking account, a savings account, certificates of deposit, a money market account or even a brokerage account. Any bank account can be linked to a debit card. The amount of funds that can be spent with a debit card is restricted to the money in the bank.
A credit card also has a line of credit. A certain amount of credit is available to the card user and can be accessed with the card. Many people get the two confused because Visa and MasterCard credit transactions can be made with many debit cards. There are also some cards that function as both credit and debit cards.
Advantages to Debit Cards
The big advantage to debit cards is that they function as cash. A person is only spending money that she actually has when she uses a debit card. Debit cards can effectively limit spending and allow a person to live on a budget. A big advantage to checking account debit cards is that a person can use the monthly statement to monitor spending.
Another advantage to debit cards is that they eliminate the need to carry around a large amount of cash. This can be dangerous and cumbersome. Finally, unlike a check a debit transaction is made with existing funds. This can prevent a person from writing a check with funds that are not there and avoid overdraft charges.
Limitations to Debit Cards
There are some limitations to debit cards, a big one is that some bank issued debit cards are really high interest credit cards. Instead of stopping transactions the bank covers them and charges a high interest rate disguised as an “overdraft” fee. This situation can be avoided by insisting on a debit card that has no line of credit or overdraft protection with it. It is possible to get a debit card that will not work if no funds are available.
Another way to use a debit card is to have two or three checking or money market accounts. Have one account for your day to day transactions that is linked to a debit card. You can also have another debit card linked to your money market or CD that you can use for emergencies or large transactions.