Smart Banking: Little-known facts on debit cards

If you’re like most Americans, you probably swipe your debit card hundreds of times a year without thinking much about it. But there are some things you should know about how that little sliver of plastic works — and the risks involved in using it.

How debit cards work

A debit card transaction may take just seconds, but there’s actually a lot going on behind the scenes, says Steve Kenneally, vice president for payments and technology policy at the American Bankers Association.

Here’s what happens when you swipe your card:

  1. Point of sale: The point-of-sale machine reads the magnetic stripe on your card to get the account number, expiration date and sometimes the card security code.
  2. Merchant’s bank: That data is transferred to the merchant’s bank (or the bank that runs the ATM) along with the amount of the transaction.
  3. Payment network: The merchant’s bank transfers that information from the transaction to whatever network your debit card runs on, usually Visa or MasterCard.
  4. Issuing bank: The payment network sends the transaction data to the bank that issued you the debit card. It checks if there’s enough money in your checking account to cover the purchase. If there is, your bank approves it. Yea!
  5. Your checking account: Your bank deducts the amount of the purchase from your available balance and adds the charge to your statement.

While this process may seem a little convoluted, it actually happens very, very quickly, Kenneally says.

“This is all done in fractions of a second,” he says. “If it took two seconds, you would be unbelievably annoyed in line.”

The process that plays out when you withdraw money from an ATM is basically the same, except you’d replace the merchant with whichever bank is running the ATM you’re using.

Merchants can knock your block off

Sometimes, merchants will send an amount to authorize that’s larger than what the transaction turns out to be, Kenneally says.

“Those are the situations where you go to buy something, but you don’t know how much it’s going to cost yet,” Kenneally says.

For instance, many gas stations block off between $50 and $100 on customer debit cards before letting them fuel up.

“The gas station wants some degree of assurance that they’re going to get paid for the gas you pump, even though they don’t know how much gas you’re going to pump,” Kenneally says.

The same goes for hotels that don’t know how much room service you’re going to eat, or car rental companies that aren’t sure whether you’ll return their car on time.

That’s great for businesses, but it’s not so great for consumers. Their debit cards may later be unexpectedly declined because a large part of their available balance has been blocked off, the Federal Trade Commission has warned.

Debit cards are fee machines

One of the biggest downsides of debit cards is they can quickly generate hundreds of dollars in fees, says Sarah Jane Hughes, a university scholar and fellow in commercial law at Indiana University’s Maurer School of Law.

The biggest of those fees is typically an overdraft fee, which banks charge debit card holders to cover purchases they don’t have sufficient cash for.

“You need to be sure when you use your debit card that there is a sufficient balance for that transaction to go forward, or you could get hit with an overdraft fee,” she says.

But it’s not just overdraft fees. Debit cards can incur ATM fees, out-of-network ATM fees from your own bank and foreign transaction fees.

Hughes recommends spending some time to get educated on your debit card’s fee schedule before you start swiping.

You’ll soon ‘dip’ instead of swipe

The advent of EMV (Europay, MasterCard and Visa) chips, which are being embedded in many new debit cards, may change the user experience somewhat, Kenneally says.

Instead of swiping, card users will “dip” their cards. Kenneally says when that happens, the chip will generate unique payment information that gives your bank everything it needs to authorize the purchase, but it can’t be reused in the future. In theory, that should cut down on debit card fraud because:

  • The merchant will never actually get any account details from your card that could be hacked and used to make purchases in the future.
  • If anyone does get your debit card information, it would be much harder to counterfeit a chipped card than a magnetic-stripe card.

Still, debit card fraud happens

Americans make more than 1,500 debit card transactions every second, according to statistics from the Federal Reserve. The sheer volume of transactions means that even though the vast majority of swipes are legitimate, there are still about 13.9 million fraudulent debit card transactions a year, according to the Fed data.

And that doesn’t include honest mistakes that banks make every year when handling and processing tens of billions of debit card and ATM transactions that go through their systems.

Whether because of fraud or a simple mistake, the odds are good that at some point in your debit card holdership, you’re going to find a transaction on your statement that you didn’t authorize, or worse, a checking account that is emptied. And that brings us to our next problem.

Weak consumer protection laws an even bigger bummer

Consumer protection laws on debit cards are not as strong as they are on credit cards, Indiana University’s Hughes says. That means there’s a lot of room for consumers to get hurt — by fraud and by bank errors.

Fraud protection has a shelf life: The longer it takes you to report fraud, the more of that fraud you’ll have to pay for, Hughes says.

  • If you report within two days, your liability is limited to $50
  • After two days but up to 60 days later, your liability is limited to $500.
  • After 60 days, your liability is unlimited.

You may be waiting a long time to get your money back: Unlike with credit cards, debit card fraud saps money directly from a victim’s checking account. While they’re waiting to get it back, they may struggle to cover expenses.

Banks may not admit errors: Banks have an obligation under the law only to investigate errors, and if they don’t see things your way, they may never return your money at all.

“If the bank doesn’t believe an error happened, it has no other responsibilities,” Hughes says. “You can sue and you can wait for your turn in court.”