Credit Cards Versus Debit Cards

Plastic cards are all the same, right? Wrong! Debit and credit cards go head-to-head over ten rounds -- and a winner emerges!

According to banking-payments association APACS, there were 141.6 million plastic cards in issue in the UK in 2005.

This total consisted of 69.9 million credit cards, 67 million debit cards and 4.7 million charge cards. With around 48 million adults in the UK, this means that we have an average of three plastic cards apiece. That's more plastic than there is in Michael Jackson's face!

The big question is: how do debit and credit cards compare? Naturally, there will be occasions when it is better to use one rather than the other. Hence, here's our detailed guide to which plastic is more fantastic!

1. Popularity

There are 40.8 million holders of debit cards in the UK, so around five in six adults (84%) have at least one debit card. On the other hand, there are around 31.6 million credit- and charge-card holders, which is around two-thirds (66%) of the adult population. Hence, debit cards win the popularity contest.

What's more, as the years go by, we become less reliant on cash and more reliant on our plastic cards, as the following table demonstrates:

Plastic card purchases, 1998 to 2005

(no. of transactions in billions; any inconsistencies are down to rounding)

As you can see, although the total number of purchases on plastic cards has doubled over seven years, the real growth has been in our use of debit cards. Debit-card purchases soared by 141% over this period, compared to a 43% increase for credit, charge and store cards.

One point to debit cards

2. History

Almost all plastic cards belong to one of six major payment-card systems, which are operated by American Express, Diners Club, JCB International, Maestro, MasterCard and Visa. These operators process transactions and transmit money through their card networks.

However, credit cards have been around a lot longer than debit cards have. The first major credit card, Barclaycard, was introduced forty years ago in June 1966. However, the UK's first debit card, the Visa Delta card, using the brand name Connect, was launched by Barclays in 1987. You can learn more about the history of plastic cards in The World Of Fantastic Plastic.

One point to credit cards

3. Ease of use

Debit and credit cards have fairly similar formats and appearances; for example, they all measure about 86mm by 54mm, and have a 16-digit number across the middle.

They work in pretty much identical ways, too. When you present your plastic card for payment, the retailer sends data to the bank which processes card transactions on its behalf, known as the merchant acquirer.

This data then passes to the card scheme (such as MasterCard or Visa), which then electronically contacts your card issuer to gain approval for the transaction. The relevant information will then be squirted back down the line, and your card issuer will debit your bank account or credit-card account and pass it down the chain. All this communication takes just a few seconds. Job done!

Most organisations which take debit cards also take credit cards, so we'll call this round a draw.

½ point to both cards

4. Additional charges

Aha, this is where things get interesting! On some occasions, paying with a credit card can incur additional handling fees and interest, which gives debit cards the edge in these circumstances.

For example, some travel agents and other outlets which process large transactions will add a surcharge of, say, 2% if you pay by credit card. On a £2,500 family holiday, this adds £50 to the bill, so paying by debit card would be the better option. Furthermore, when you buy foreign currency on your credit card, some issuers apply the same charges and sky-high interest rates that they levy on cash withdrawals (see below). The same goes for online gambling and other cash-like transactions, so beware!

Another point to debit cards

5. Withdrawing cash

In 2005 alone, we used our plastic cards to make 2.7 billion cash withdrawals from automated teller machines (also known as ATMs, cash machines, holes in the wall, etc.), plus a further 108 million over-the-counter cash withdrawals.

Debit cards are ideal for drawing cash. Off the top of my head, I don't know of any which charge fees for cash withdrawals from non-commercial machines or over-the-counter transactions in branches.

Credit cards, on the other hand, should NEVER be used for cash withdrawals! Why not? Simply because credit-card issuers charge withdrawal fees, typically 2.5% of the amount withdrawn, minimum £2.50 -- and these fees are creeping up. In addition, most credit cards don't provide any interest-free period for cash transactions, so you start paying interest at ultra-high cash rates (usually 20% APR or more) from day one. Credit cards and cash machines don't mix, so don't let them meet!

Another point to debit cards

6. Fraud and legal protection

If money is fraudulently taken from your current account or credit-card account, and you haven't been negligent with your card and PIN, then you are only liable for the first £50 of any theft. However, if you've carelessly revealed your PIN (perhaps by writing it down on a document kept with your card), then you will foot the entire bill -- and learn a valuable lesson about information security! On this count, credit cards and debit cards offer a similar level of consumer protection.

However, credit cards have the edge when it comes to paying for goods costing £100 or more, thanks to the valuable legal rights afforded by Section 75 of the Consumer Credit Act. If you order goods or services costing between £100 and £30,000, in the UK or overseas, and pay even a £1 deposit with your credit card, your card issuer stands in the shoes of the supplier if the goods fail to arrive, are damaged or faulty, or are otherwise unfit for their intended purpose. Hence, if you don't want to lose your money if a supplier goes bust, stick to paying with your credit card for goods costing £100+!

To fend off financial fraud, read Ten Tips To Prevent Financial Chaos.

Another point to credit cards

7. Interest-free periods and interest rates

If you always pay off your credit card in full every month, you can enjoy an interest-free period which typically lasts between 45 and 59 days. However, if you don't, you can expect to pay annual rates of interest which average around 16% a year, but can exceed 30% APR! (To avoid this problem, you can use a 0% on purchases credit card, which offers an introductory interest-period lasting up to a year.)

On the other hand, when you make a purchase using a debit card, the money is debited from your bank account within a day or two, so there's no effective interest-free period. What's more, you won't pay any interest while your current account is in credit -- and you could earn more than 5% a year on your credit balances in a Best Buy current account. However, if your spending takes you overdrawn or you exceed any approved overdraft limit, you'll face a frightening assortment of charges and mega-high interest rates, so stay out of the red if you don't have prior permission!

Another point to debit cards

8. Cashback, loyalty and rewards schemes

I can think of only one debit card which rewards you for spending on it: the debit card which comes with a Halifax Moneyback current account. This pays you 1% moneyback on the first £10,000 of annual spending on your debit card, then 0.1% on the remainder over £10,000, which could add up to £100+ a year.

In contrast, there are dozens of cashback and rewards credit cards to choose from, the best of which pay up to 3% cashback for an introductory period. Personally, I do all of my shopping on my cashback card, as I pay off my entire bill each month by direct debit and earn around £10 a month cashback as I shop. Result!

Another point to credit cards

9. Annual fees

Although I don't know of any debit cards which charge an annual fee for normal usage, I am worried that in-credit free banking could be on the way out, as I warned in Is Free Banking Doomed?

Likewise, although there are around 1,300 differently branded credit cards on offer in the UK, very few charge annual fees as standard (but some card issuers are targeting unprofitable cardholders with tailored annual fees of up to £25). For the record, I exposed the eleven credit cards which charge annual fees in The Return Of Credit-Card Fees.

½ point to both cards

10.Credit limits

Finally, we come to the tricky subject of credit limits. With a current account, you can freely spend as much as you have in your account, plus the value of any approved overdraft. Thus, with a £2,000 credit balance and a £1,000 authorised overdraft, you could spend up to £3,000 before penalty charges kick in.

On the other hand, credit cards encourage millions of people to spend money that they don't have. Indeed, many people see a £10,000 credit limit as a target, and assume that they have been given an extra £10,000 to go mad with in the shops. Bad move! With banks sending out credit-card offers in their millions every week, easy credit could easily become tough debt when times get hard. Hence, I'm awarding the final round to debit cards, not debt cards!

Final point to debit cards

After ten rounds, here is the judge's decision: credit (debt) cards have a respectable four points, but debit cards win the contest with six points. Throw in the fact that most debit cards also double as cheque-guarantee cards, and debit cards win by an even bigger margin.

This decision is mine and it's final, but if you disagree with my ruling, then click on Give feedback below and have your say!

More: Use the Fool to find first-class credit cards, current accounts and savings accounts