Why the Choice Between Debit or Credit Matters

Who Pays Interchange Fees?

Business owner paying bills at laptop in cafe
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When making purchases with a debit card, you can often choose to make the transaction a debit or credit purchase. What’s the difference? The choice you (or your customers) make determines how the purchase is processed, the cost of processing, how long it takes, and your rights.

Buyers get to choose how to pay, and most don’t understand how important that choice is.

Is It Debit or Credit?

The choice between debit and credit is the difference between an online and an offline transaction.

“Debit” results in an offline transaction at checkout.

  • You’ll enter a personal identification number (PIN) to verify your identity.
  • You might be able to get cash back with some merchants.
  • Merchant fees are lower, but banks might charge cardholders an additional fee for choosing debit.
  • The transaction is completed electronically, typically immediately or within the same business day.

“Credit” leads to online transactions at checkout.

  • You’ll sign (on a charge slip or screen) for the transaction instead of entering a PIN.
  • The purchase typically runs through credit card networks (like Visa and MasterCard).
  • You do not borrow money like you would with a credit card — the funds come out of your checking account.
  • It may take several days for the charge to hit your account, but an authorization hold might tie up money in your checking account for several days.
  • Merchants may pay higher swipe fees.

Why It Matters

Consumers typically don’t care whether a purchase is a debit or credit transaction, but banks and retailers do.

Merchant fees: The retailer pays a percentage of the total purchase price for payment processing. The details depend on several factors (transaction size, whether the card was present or not, and more), but it’s often less expensive for retailers to process offline (PIN-based) transactions than online payments.

For small purchases, even offline fees can add up to a few percent of a purchase, eating into retailers’ margins.

How much? The Durbin Amendment limits debit card interchange fees to 21 cents plus 0.05 percent of the payment. An additional one cent fraud-prevention charge is also allowed in some cases. Those rules only apply to “covered transactions,” which include cards issued by some of the largest card issuers. However, other card issuers can charge more. For example, those rules only apply to banks and credit unions with $10 billion or more in assets. In 2015, the Federal Reserve reported that debit card transaction fees are typically around $0.24 per payment. On average, exempt (non-covered) transactions cost $0.51 on average.

Incentives for cardholders: To maximize revenue, some banks give customers an incentive to choose credit (or a penalty for choosing debit, depending on how you look at it). In the past, they have charged fees for online transactions – usually in the ballpark of one to two dollars. Faced with those fees and the feeling of being nickeled-and-dimed, customers become more likely to choose credit. They may also offer rewards like the opportunity for a better interest rate (in reward checking accounts), airline miles, or entry into a sweepstakes when you choose credit.

 

Ultimately, somebody pays, whether it’s the retailer or the customer.

Retailer workarounds: Banks and payment processing companies would love for you to choose credit because they get a few percent of every dollar you spend. Retailers, on the other hand, beg to differ. They’d prefer that you choose debit so that they don’t have to pay a hefty interchange fee. In some cases, they add credit card surcharges (which aren’t allowed with debit card purchases under federal law) to that pass that cost on to customers who pay with plastic. Debit card minimums are another tactic, but payment networks prohibit those minimums.

Account holds: Choosing to buy with a debit or credit transaction also affects your bank account. If you’ve ever paid for gas at the pump, you know that you swipe your card before pumping gas.

The machine doesn’t know how much gas you are going to buy, so the gas station owner has to make some decisions. Typically, they check to see if you have at least $50 or $100 available in your account – effectively pre-authorizing a purchase for that amount. If authorization comes back, the retailer “blocks off” that $50 or $100 so you can’t spend it elsewhere.

You might only by $10 worth of gas. Nevertheless, $100 will be frozen in your account for several days. In a worst-case scenario, you’ll end up bouncing checks even though you have the money – it’s just not available for spending. If you use your debit card for everyday purchases, you need to be careful. Two ways to protect yourself include:

  1. Keep extra cash in your checking account.
  2. Use your PIN if you don’t have extra cash in your checking account.

Note that using your PIN will make the transaction clear your account more quickly. However, there is a security issue. By entering your PIN number, you run the risk that somebody else will discover it. Thieves (or a hidden camera) may see which numbers you hit on the keypad, or the retailer’s device could give up your PIN – whether on purpose or by accident.

If your PIN is compromised, scammers have direct access to your checking account. They can create fake cards and spend your money, or they may even create a fake ATM card to make cash withdrawals. If they drain your checking account, you won’t be able to pay important bills. Fortunately, chip-enabled cards will reduce the risk somewhat.

Your account may be protected from fraud, but you’ll have to go through some difficult days or weeks without your money while the issue is resolved at your bank.

Your Rights With a Debit Card

Debit cards and credit cards both provide consumer protections, but credit cards are more generous. You are still protected if your debit card is used by a thief or charges hit your account in error — but you have to act fast. Compared to credit cards, debit cards expose you to more personal risk. With credit cards, you’re limited to $50 of liability for fraudulent use. What’s more, the thief will spend the bank’s money — he won’t empty your checking account and cause you to bounce important checks (or rack up fees for insufficient funds).

With a debit card, you are protected as follows (Source: Federal Reserve and Federal Trade Commission):

Your loss is limited to $50 if you notify the financial institution within two business days after learning of loss or theft of your card or code.

But you could lose as much as $500 if you do not tell the card issuer within two business days after learning of loss or theft.

If you do not report an unauthorized transfer that appears on your statement within 60 days after the statement is mailed to you, you risk unlimited loss on transfers made after the 60-day period. That means you could lose all the money in your account plus your maximum overdraft line of credit, if any.

Given the added risk of loss, plus the headaches of risking direct access to your checking account, your life may be easier if you use a credit card for purchases. Just pay it off in full every month to avoid interest charges (taking advantage of the grace period). Still, there may be times when it makes sense to stick with debit cards: you might not be able to qualify for a credit card, you might want to help a youngster develop good habits, or you just might not like the idea of debt — even temporary debt without interest charges. To address some of those problems, work on building up your credit history to qualify for better (less expensive) cards, or try a prepaid debit card without a direct link to your checking account.