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 spending money with a debit card, you can often choose between a debit or credit transaction. What’s the difference? The choice you (or your customers) make determines how much payment processors charge, how long it takes for money to move, and other things.

Customers get to choose how to pay, and most of them don’t know 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 enter a personal identification number (PIN) to verify your identity.
  • You might be able to request cash back from some merchants.
  • Merchant processing fees are typically lower. Banks rarely charge consumers for choosing debit, but it’s possible.
  • The transaction takes place electronically, typically immediately or within the same business day.

“Credit” leads to online transactions at checkout.

  • You sign (on a charge slip or screen) for the transaction instead of entering a PIN, although signatures are optional in many cases.
  • The purchase typically runs through credit card networks (like Visa and MasterCard).
  • You do not borrow money as 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 for credit transactions.

Why It Matters

Consumers usually 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 meaningful percentage 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. In some cases, merchants might pay an additional one-cent fraud-prevention charge. Those rules only apply to “covered transactions,” which include cards issued by some of the largest card issuers nationwide. 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. 

For 2018, the Federal Reserve reported that debit card transaction fees are typically around $0.24 per payment. On average, exempt (non-covered) transactions cost $0.54.

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—around $1 or $2—but that’s not a widespread practice. Banks and card issuers 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.

Retailer workarounds: Banks and payment processing companies would love for you to choose credit because they receive more revenue for every dollar you spend. Retailers, on the other hand, beg to differ. They prefer that you select debit so that they don’t have to pay hefty interchange fees. 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 assumptions. 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 is 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.

Using your PIN makes the transaction clear your account more quickly, but there is a security issue. By entering your PIN, 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 in a data breach.

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 attempt 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 may experience several difficult days or weeks without your money while your bank resolves the issue.

Your Rights With a Debit Card

Debit cards and credit cards both provide consumer protection, 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 payments (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 potential for 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, which does not have a direct link to your checking account.