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Debit cards: Everything you need to know

At a glance:

Debit cards have grown greatly in popularity in recent years for their convenience. They have eclipsed check writing and even credit cards among many people. If you are like the average shopper, you've probably been using them for some years now.

(Getty)
(Getty)

How debit cards work

A debit card is a plastic card that gives the cardholder electronic access to a bank account in his or her name at a financial institution. It also goes by the name of check card or bank card. The purpose of a debit card is to pay for goods and services with funds taken (debited) from that account. The funds are transferred immediately from the account to the vendor.

A debit card therefore differs from a credit card; with a credit card, you get billed in a few weeks and must make payment then.

The appeal of debit cards is convenience. It's easier and faster for most people to carry a small plastic card than a checkbook or a wad of cash.

The fees

Debit cards are not always free to use. There are overdraft fees if you withdraw more money than you have in your account. If you use your card at an ATM not run by your financial institution, you may be charged a fee. There may be fees for simply having the card, fees for not using the card, fees for ATM use at your own financial institution, activation fees, and some customer service fees. Some institutions even charge you a fee if you enter a PIN (personal identification number). As debit card use grows around the world, there is the potential for more fees to be put into place. Your financial institution must, by law, disclose all fees it charges on debit cards.

There are two ways for debit cards to be used at the point of purchase:

  • With a PIN. In this case, you swipe your card through the merchant's electronic machine, press "Debit," and enter your PIN. You don't need to sign for the purchase. You may even have an opportunity to get cash back, meaning that you authorize the card to withdraw additional money from your account.

  • With a signature. In this case, you swipe your card through the merchant's electronic machine, press "Credit," and enter your signature with a plastic pen. In this case, you are technically using it as a credit card even though funds are still being withdrawn from your account.

Varieties of debit cards

Owing to their ease of use and their ability to tie into an existing source of money, debit cards have assumed many different uses. As they grow in popularity, look for them to pop up in places where people want to access their own funds.

HSA and FSA debit cards

Debit cards are available with many health savings accounts and flexible spending accounts. These accounts are funded with tax-deferred money. With them, you can pay for products and services that are covered by your HSA or FSA, such as medications. The cards withdraw funds from your account at the point of purchase. There are rules, limits, and guidelines for using these cards, many of which are set by the institution offering your card. One note: withdrawals are meant to be used only for eligible medical expenses. If you use your card for an expense that is not eligible, you will have to pay income tax on it when you fill out your tax forms for that year.

401k debit cards

Debit cards now exist for 401k plans, allowing you easy access to your funds. The funds must be paid back, though, as they are actually loans. There are rules and regulations on the use of these cards.

Prepaid debit cards

Prepaid debit cards are also called gift cards and reloadable cards. They allow you to add money to them and build up a balance. Typically, you buy them with a certain amount of money already on, and depending on the card, you can add additional funds. Prepaid cards tap into the large pool of people who have little or no access to bank or credit union accounts and those who are wary of using credit cards for certain purchases.

Payroll cards are a type of prepaid debit card offered as an alternative to a paycheck or direct deposit. Your wages get loaded onto the card for you to use.

Despite these advantages, prepaid debit cards come with fees. You may be charged a monthly fee just for having the card. Sometimes you get a grace period before the charging starts. There may be fees for periods of inactivity. You will likely be charged a fee each time you use the card. Finally, there are often activation fees. You might also be docked each time you inquire about your card's balance. Planning to call customer service? Some cards have fees just for that.

Rewards cards

Rewards cards are incentive programs offered by financial institutions and businesses to persuade you to spend money with them. They pay you when you use the cards at select locations. With some, you amass points. With some airlines, you amass miles. Still others deposit cash into a bank account that they are tied to. This cash may be a percentage of the purchase price or a set amount for certain purchase thresholds. They thus work in a manner similar to how cash-back programs work for credit cards. Various rules exist for these programs. For example, a bank might require you to keep a certain minimum amount deposited in order to get the rewards.

A debit card is swiped at a parking meter in Washington. (Photo: TIM SLOAN/AFP via Getty Images)
A debit card is swiped at a parking meter in Washington. (Photo: TIM SLOAN/AFP via Getty Images)

How debit cards compare with credit cards

Their ease of use has helped make debit cards more and more popular every year. Like every popular product, there are downsides that can affect you if you are not careful. Let's look at the pros and cons of debit cards and how they compare with credit cards.

Advantages

  • Debit cards are easier to obtain than credit cards. This is an advantage to those who have difficulty getting credit cards.

  • Debit cards finalize transactions on the spot. You don't get a bill sometime later.

  • Having the money come out of your account right away can put a damper on overspending.

  • You can't run up balances like you can with a credit card.

  • You don't need to present identification when using your debit card.

  • Less scrutiny is required of debit cards than personal checks.

  • It generally costs less to get cash from a debit card than from a credit card (user fees may still apply, though). There are no finance or interest charges as there are for credit cards.

  • Overdrafts may be prohibited, which can protect undisciplined spenders.

Disadvantages

  • Payment is on the spot. Although this is an advantage to some, others prefer having a few weeks to pay their bills.

  • Large purchases can drain your account. Credit cards won't do this.

  • You are limited to the amount of funds in your designated account. If you spend more than is in your account, you may be charged an overdraft fee. This is contingent upon your authorization, however, due to recent legislation. Depending on how you view your discipline, this could even be an advantage for you.

  • There can be a whole host of fees other than point-of-purchase fees. There may be fees just for having the card, fees for not using the card, ATM fees, activation fees, and various customer service fees. If you do not plan well, they can eat a big hole in your balance.

  • If you do not authorize overdrafts, then your ability to spend money is limited to what is in your account.

  • Protection against unauthorized use of your debit card is limited, compared to that of a credit card. Liability is limited to $50 if you report it within two business days, but $500 if you notify your institution within 2–60 days.

  • No right to withhold payment in the event of a dispute with the merchant.

  • There is no ability to place a "stop payment" on a transaction.

  • If your final bill for a service is uncertain, such as at a hotel where you could run up a room service tab, a debit card may be an unwise choice. The hotel could put a hold on your account for the room rate plus an estimate for additional expenses. This hold could put you at risk for overdrafts.

  • Debit cards don't typically provide extended warranties, and some credit cards do.

One idea for dealing with the cons: set up a separate account just for debit purchases. Don't link this account to any others.

Protections for debit card holders

Debit cards do not yet have the same level of protections that credit cards do. As debit card use grows, the legal landscape surrounding their use may change. For now, there are some laws that protect cardholders.

The Electronic Funds Transfer Act (EFTA) was passed years ago to regulate electronic transactions. It protects you from errors, loss of funds, and theft of your debit card. Its protections are not as sweeping as those of the Truth in Lending Act, which provides protections for credit cards.

Errors

Under EFTA, in the event of error your financial institution must do the following:

  • Investigate the error and resolve it within 45 days.

  • Investigate errors involving new accounts (opened in the last 30 days), point-of-sale transactions, and foreign transactions within 90 days.

  • Recredit the amount in question if it takes more than 10 business days to complete the investigation (20 business days if your account is new).

  • Notify you of the results of the investigation.

On your end, you are responsible for contacting your institution as quickly as possible, with as many details as you can.

Losses or thefts

If you report the debit card missing before any transactions occur, you will not be held liable for any losses that occur. Your loss is limited to $50 of any unauthorized transactions if you notify your institution within two business days. Your loss is up to $500 if you notify your institution between 2 and 60 days. If you wait until after 60 days, you are liable for all losses that occur.

As a goodwill gesture, many banks have reduced that $500 limit noted above to only $50. Some banks do not charge you anything if unauthorized withdrawals appear on your statement.

For your part, you must provide your notice in writing.

Overdraft protection

It goes without saying that some consumers are not vigilant with their finances and can spend more than is in their accounts (in other words, they cause an overdraft). Overdraft fees are the natural result of this. However, fraud and merchant errors can also cause an overdraft.

There are protections available for overdrafts. Customers in good standing with their institutions can have overdrafts covered. The institution simply gives them the amount of the overdraft as an instant loan. For this service, there is an overdraft fee. If they have another account at that institution, the institution can borrow from this account to replace the amount of the overdraft. Fees for this service may be lower than regular overdraft fees or even waived, depending on the institution and your standing with it.

In 2010, the Federal Reserve began allowing customers to opt out of this overdraft protection. That means that they will not get overdrafts covered—instead, their debit purchases will be declined. This protects customers from overdrafts as well as fees and—in the minds of some—their own lack of vigilance over their money.

How to prevent debit card fraud

Fraud can be a time-consuming, emotionally exhausting mess. There are federal protections for you if you are the victim of fraud, but you want to prevent fraud from occurring in the first place. Here are some tips for keeping your card safe:

  • Don't share your PIN with anyone unless they are a co-owner of your account. Internet scams often start out with a person trying to become your friend online and then seeking financial "help."

  • Do not write your PIN on your card or near it. It's best to memorize it.

  • Keep your card in a safe place and stay in the habit of doing that. Some people lock it away in a safe until they need to use it, and then put it back when done.

  • Review your bank statements as soon as they arrive; time will be of the essence when discovering and reporting any discrepancies or unauthorized charges. The earlier you report suspicious activity, the less your liability for unauthorized charges will be.

  • Do not give out your bank information over the phone or online to anyone unless you initiated the contact or you know the person on the other end. Criminals are known to call people and ask them to "verify" their account information. Spam emails are notorious for doing this.

  • When using your PIN in a card machine, make sure no one can watch the transaction. That includes watching the motions you make with your hands.

  • Consider not giving your card to clerks at retail spots (restaurants, stores, etc.), but instead use a do-it-yourself scanner at the counter.

  • At restaurants, if you see a blank line on a receipt and don't intend to fill it in with numbers, draw a line through it. This will prevent unauthorized charges from being written in there.

  • When shopping online, are you using a firewall? Do you have spyware protection?

Summary of debit cards

For many people these days, a debit card is the ultimate in convenience—no cash or checkbook to carry around, no interest payments to factor in, and no bill to pay weeks down the road. Debit cards are a booming part of the economy. If you are a typical shopper, you've probably had your share of them.

Proper use and carefulness can prevent fees and fraud from eating away at your money.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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