Cash or debit vs. credit: What’s the best way to pay?

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It may not seem like there’s much of a difference when you’re facing the decision at the register, but choosing between using a credit card and cash can have a big impact.

While many people only use their credit cards for large purchases or at the stores in which they’ll earn rewards, responsible credit users can often get even more value from their cards by using them for everyday purchases, from groceries and gasoline to mall shopping trips and office lunches.

Before jumping into a few instances comparing whether using credit cards or a debit card is more beneficial, it is important to understand the difference of how each of these work.

What’s the difference between credit cards vs debit?

How do credit cards work?

Credit cards begin with an application process. In that application process, the credit card issuer will review a person’s credit history and credit score.

After an individual is approved for a card, a line of credit is extended to a customer by the credit card issuer. This line of credit is a monetary amount based on factors such as a customer’s financial history, credit score, and their current income, which are all factors the credit card company uses to assess the likelihood that the customer will be able to pay back their line of credit.

Making purchases with a credit card is essentially borrowing money from a lender that must eventually be paid back. This revolving credit replenishes when you make a payment towards the total debt balance.

How do debit cards work?

Debit cards are linked to a personal checking account meaning the amount you can spend with your debit card is limited by the amount of cash you have in the bank.

There is no application process involved with debit cards. Debit cards are automatically provided when you open your checking account to complete simple transactions such as withdrawing cash from the account or making everyday purchases.

While paying with a debit card may feel the same as using cash, there is a delay in the transactional process that may lead to issues of overdrawing on your reserve of funds. For this reason, it’s important to keep an eye on the running balance of your checking account or monitor the account to make sure that you don’t spend more than you have in your account. This prevents the accidental overdraw of funds and avoids the heavy fees associated with being overdrawn on a checking account

When to use a credit card

Making purchases with a credit card can give you an extra sense of security and help you earn rewards each time you swipe. If you use your credit cards responsibly and pay your balances off each month, there’s no reason not to take full advantage of the benefits and get in the habit of using them regularly.

When you’re paying at the pump

Gas station fuel pumps are some of the riskiest places to pay, since many haven’t yet implemented EMV chip readers and credit card skimmers can easily swipe your information when you pay at the pump.

According to a recent survey by GasBuddy, more than half (51 percent) of consumers still prefer to pay with their debit cards at gas stations. “It’s easy to use” was the most commonly-cited reason for preferring debit over credit.

But it can be dangerous to use your debit card, which is tied directly to your bank account, over a credit card, especially when the card reader at the pump prompts you to swipe your card instead of inserting the EMV chip.

Regardless of what type of card you use, your liability is limited by law. If you report a lost or stolen credit or debit card before any unauthorized use, you’re not responsible for any fraudulent charges. With a credit card, your liability cannot exceed $50 and if the number is stolen but not the card, you are not liable for any amount. With a debit card, you must report your lost or stolen card within two business days in order to limit your liability to $50. If you report within more than two business days but less than 60, your liability goes up to $500. If just your debit card number is stolen and not the card itself, you are not liable for unauthorized charges as long as you report them within 60 days of receiving your statement.

If someone skims your credit card information, you have time to dispute the charge before you’re liable for the payment, and the pending charge may never even post to your account. If you use a debit card, though, the funds can be removed from your bank account directly and quickly, making the process of disputing and getting your money back much more time-consuming.

When you’re shopping online

For similar security reasons, you should always pay for online purchases with a credit card rather than debit.

Online fraud (as well as fraud occurring over the phone or via mail) is known as card-not-present fraud, and it’s becoming much more prevalent than in-store (or card-present) fraud. According to a 2018 study by the Federal Reserve, card-present fraud is on the decline, shrinking from $3.68 billion in 2015 to $2.91 billion in 2016, while card-not-present fraud is rising. Total card-not-present fraud rose from $3.40 billion in 2015 to $4.57 billion in 2016.

While you’re still protected from liability if you experience card-not-present fraud with a debit card, it can be much less of a headache to dispute unauthorized charges on a credit card, when the funds haven’t already left your bank account.

When you’re building credit

Establishing great credit is one of the best ways to set yourself up for long-term financial success. Your credit score is a key factor in determining the interest rates you’ll pay and eligibility for loans like mortgages, car payments and more. Using your credit cards responsibly can go a long way to building your credit, even if you’re starting out with a thin credit file.

If you want to raise your credit score, use your credit card to make purchases and pay your statement balance in full each month, being careful to keep your credit utilization rate under 10 percent. A 750 or 800 credit score isn’t made overnight, but practicing good habits with your credit cards and showing discipline to potential lenders can lead to success with loan qualification and lower interest rates down the road.

When you’re earning rewards

If you don’t have trouble sticking to a budget, using your credit cards to make the majority of your everyday purchases is an easy way to quickly rack up rewards.

Choose credit cards with rewards that align with the categories in which you spend the most, and you can earn hundreds of dollars in cash back or collect thousands of rewards points on things you would already buy anyway. Just remember to pay your balances off each month so you don’t owe more in interest than you earn in rewards.

Many cards offer other benefits too, like rental insurance and extended warranties, which can add value to your purchase and tip the scales in favor of purchasing with your card.

When to use cash

As great as credit cards can be for earning points and making secure purchases, there are times when using cash or a debit card is the better move. Maybe you have a habit of spending more than you have available in the bank when using your credit card or you’re shopping with a merchant where credit card payments are more complicated (or more expensive). Here are a few examples of when to use cash or debit:

When you’re carrying a balance

If you’re already carrying a balance on a credit card, it’s wise to keep from charging anything else to it.

Make the switch to cash while you’re working to pay down your balance so you don’t risk falling behind on payments or accumulating more interest. This can help you get in the habit of not spending more than you can afford now while also building good habits to keep you from taking on more credit card debt in the future.

When you’re having trouble budgeting

A credit card can be a useful budgeting tool, but it can also throw your budget off completely if you’re not careful.

Similarly to when you’re paying down debts, if you’re having difficulty sticking to your budget, using only cash is a simple way to keep yourself from overspending. Use a cash-only budgeting trick like the envelope method to designate a specific amount of cash for each of your budget categories (groceries, utilities, dining out, etc.), then only take out that amount from you account in cash so you’re less tempted to go over. This can help you get in the practice of only spending what you can afford.

When you need to make a small purchase

It’s not uncommon for small local business to have signs posted with notices like “$10 minimum for credit card purchases.”

Merchants have to pay an interchange fee each time a customer pays with a credit card, which is usually around 3 percent of the transaction total. That means if you buy something with your card from a store for only a couple dollars, the merchant is likely to make little or even no profit after accounting for fees.

To keep from buying unnecessary extras in order to meet a card minimum and to make things easier for the merchant, it can be helpful to have some cash on hand to pay for small purchases at your local mom-and-pop stores.

In case of emergency

In a similar vein, it never hurts to always carry some cash with you for emergencies, even if you charge the majority of your purchases to your credit card.

Just as you should have an emergency fund of three to six months’ expenses saved up for a rainy day, it can be helpful to have a mini emergency cash fund in your wallet for times when your card is declined, there’s an error with the card reader or you want to make a purchase with a merchant that doesn’t accept cards.

The amount you need is up to you; maybe you feel comfortable with just a $20 bill or prefer $40 or $50 or more. But when paying with cash becomes a necessity, you’ll thank yourself for your forward thinking.

Bottom line

If you use your credit card responsibly and don’t accrue interest on balances, the benefits of using your credit cards for everyday purchases, from groceries and gas to dining out and regular shopping, often outweigh the cost. But there are circumstances in which having cash or paying with a debit card can help you save money or may just be easier.

Figure out what works best for you, but remember that it can pay significantly, both in rewards and long-term, less tangible benefits like security and creditworthiness to get in the habit of using your credit cards more like a debit card or cash by charging your everyday purchases and then paying your balances in full each month.