Cash was once — and probably still is — the preferred mode of payment.
In early 90s, however, Credit Card emerged as a worthy competitor to cash.
And, around 15 years back, Debit Card made its debut as the third option to make payments.
While everyone understands cash, quite a few users are still confused between the two card-based payment systems i.e when to use credit card or debit card. They are quite different and each has its own advantages.
First, let’s understand the ‘basic’ functioning of the two.
Logically there is no difference between Debit Card and Cash. In both cases, there is an ‘immediate’ transfer of money from the buyer to the seller. The only difference being physical exchange of money in case of Cash; whereas in Debit Card the transfer happens electronically from one account to the other.
Logically there is no difference between Credit Card and a Loan. When you swipe your Credit Card, the issuing bank will make the payment to the seller on your behalf. And, you have to in turn repay to your bank when the credit card bill becomes due; which is generated on a monthly basis. In other words, this mode of payment is a ‘short-term’ loan.
Typically, if the bill amount is cleared by the due date, such a loan carries no interest. But, the amount not paid and carried forward will be charged interest. (WARNING: Since the interest rate on credit card unpaid amounts is quite high, ideally you should ALWAYS pay your bills in time.)
In short, Debit Card means immediate outflow of cash and Credit Card means deferred outflow (with or without interest).
Because (a) there is a difference in the ‘timing’ of cash outflow and (b) the likelihood that you may have to pay ‘interest’, sometimes using your Credit Card is better compared to the Debit Card; and vice versa on other occasions.
Four instances when you should use your Debit Card
1. To avoid overspending
Debit Card is as an excellent tool to stop us from going overboard with our shopping spree. Since the amount available in our bank account is almost always limited, we have no choice but to spend only on the necessities, and skip the needless extravagances.
2. If careless with paperwork / bills
Some people simply cannot manage their paperwork or often misplace their bills. If that be so, why add one more Credit Card bill to keep track of and run the risk of paying interest in case of delayed payment? So, stick to the bill-free Debit Card.
3. Not run up enormous interest costs
With Credit Card there is a risk of creating a huge interest burden, if the bills are not cleared before the due date. Debit Card keeps your finances safe and secure by not creating any unnecessary liability.
4. Withdrawing cash from the ATM
Only use the Debit Card to withdraw cash at the ATM. NEVER use your Credit Card for such purpose. Because for cash, the interest meter starts the moment the cash is dispensed (unlike purchase of goods, where we enjoy some ‘interest-free’ period). Because, in addition, we also have to pay certain transaction costs and taxes.
Four instances when you should use your Credit Card
1. Insufficient balance in bank account
It is but obvious that when your bank balance is running low, you have no choice but to depend on your Credit Card. Beware. Make sure that you limit your purchases to essential requirements only. No splurging please. And, also make sure to make full payment before the due date to avoid creating any interest burden.
2. If you are sure that you will pay off the bills before time
Depending on the date of purchase, you can generally enjoy an interest-free period of 20-50 days. So, if you are 100% certain of making your payment by the due date, you can use your Credit Card. Meanwhile, the money remains with you and you can earn some decent interest on it by parking it in a liquid fund.
3. To build a good credit score
Credit Score is increasingly becoming an important parameter both to get loans easily and at cheaper interest rates. By ‘judiciously’ using our Credit Card and making ‘timely’ payments every month, we can improve our Credit Score. This will be really helpful for our future home loans, education loans and other borrowings.
4. For shopping online (preferably thru’ virtual credit card)
Most banks allow you to create a Virtual Credit Card (VCC) out of the limit sanctioned on your physical Credit Card. Since, the risks of hacking are quite high in online shopping, it is best to create a VCC (which may be for one-time use or for a small part of your total limit). This protects the sensitive data on your main card from being hacked and misused.
Three instances when both Cards are Ok
1. To have a detailed record of expenses
Both Credit and Debit Card create a detailed item-wise record of our purchases, as compared to using cash. This data could be quite useful in preparing our future household budgets.
2. Earn reward points that can be redeemed for free gifts
Both Credit and Debit Card offer reward points on usage. Once you accumulate sufficient reward points, you can exchange them for a wide variety of free gifts.
3. When carrying large amount of cash is not safe
Both Credit and Debit Card offer physical safety, as carrying large amount of cash can be a serious threat to your money… and your life too.
That’s it! This is how we should ideally use our Debit and Credit Cards. Using appropriate card for each occasion is one of the important ways to manage our personal finances in the right manner.