Debit vs. Credit: Understanding the differences and advantages

Most people have credit and debit cards on-hand at all times, tucked away in their wallet or virtually on their smartphone. These cards may look and feel the same, but the way they work is entirely different. Understanding these differences is key to being in control of your money, and will save you from making costly mistakes.

Knowing when to use debit and when to use credit is one of the most valuable money-management lessons you can learn. It's critical to building a strong financial profile, which you'll need when you want to make milestone purchases such as a house or car. It's also important as you'll often find yourself under pressure to make split-second payment decisions at contactless terminals and online check-outs.

This article breaks down the distinctions between both types of cards, highlights their advantages, clears up common misconceptions and gives you a roadmap for choosing the right one for each financial situation.

Let's get into it.

A debit card is directly linked to the bank account you use for everyday transactions. It's simple: there's money available in the account and when you make a purchase, funds are immediately withdrawn. 

As debit cards are essentially like a digital version of cash, they can help to control spending. If there's no money in the account, the transaction will be cancelled or rejected immediately. This way of spending is quick and clean with no borrowing, no monthly repayments and no accumulation of interest. 

While most debit cards function the same way, they come in a few variations. There's the standard debit card that's linked to your everyday account for purchases and ATM withdrawals, pre-paid debit cards that are loaded with a specific amount of money and debit-ATM combination cards that are primarily for cash access and simple banking transactions.

What are the advantages of debit cards?

There's a whole lot to like about debit cards.

First of all, they keep you in control of your spending. You have to have money available in your linked account in order to buy anything. There's no tempting credit limit or magical buy-now-pay-later option. Overspending on a debit card just isn't a thing, unless your bank has an overdraft facility, and you can opt out of that. 

By default, the debit card holder develops responsible habits, such as staying within a budget. For those who can't seem to resist an impulse buy, this is the ultimate financial flex.

Secondly, there's low risk of interest or sliding into debt. What makes a debit card especially appealing is that you can't go into a negative balance if you've switched off the overdraft option. That means no monthly repayments, no late fees because you forgot to pay your monthly repayment and therefore no risk of snowballing debt. 

Thirdly, you have instant access to cash. Most debit cards can be used at an ATM, where you can withdraw money whenever you need it. The same rule applies: if there are no funds in the account, no withdrawal can be made. Your debit card only gives access to money you actually have.

Lastly, your debit card is like a mini money manager in your wallet. Since transactions come directly out of your account, your balances will update in real time so you know what you've spent and where, and how much you have remaining. Set up SMS alerts to amplify your accountability and keep track of what you've spent. The fuss-free set-up of a debit card makes it much easier to stay on top of financial goals without the stress of repayments. 

Okay. By some, credit cards are considered the debit card's evil twin, but they're not. They do look and feel the same as a debit card and can lure you into snapping up shiny things you can't quite afford, but they're also a critical financial tool. For these reasons, it's important to understand what you're signing up for and to spend responsibly.

Your credit card allows you to borrow money from your bank (or card issuer) up to a set limit. Think of it as a short-term loan. If you repay the balance in full every month, then you won't accrue interest on what you've borrowed. If you don't, interest is added to the amount you owe. The danger is that if you're not careful, the outstanding amount can snowball.

How do credit cards work?

Before issuing a credit card, your bank does its homework and will calculate a credit limit that it knows you can afford to repay. This is the maximum amount you can spend using the credit card. The rest is fairly straightforward; you can buy things using the credit card, then you receive a statement summarising what you owe. You can then choose to pay a minimum amount or the full balance in order to dodge paying interest. 

What's the benefit of a credit card?

It's true that when you use a credit card you're borrowing money from your card issuer, but zoom out to get a better perspective. When used well, a credit card is a financial tool with built-in protections and long-term benefits. 

Using a credit card responsibly is one of the fastest ways to build a strong financial profile. Your credit history (how long you've held a credit card, payment history and credit utilisation) will count towards the calculation of your credit score and your credit report -- two things you're likely to need for future loans or mortgages.

The second major benefit is that credit cards often come with structured reward systems that can pay off. When choosing a credit card, look for perks such as cashback offers on everyday purchases, airline miles, discounts and promotional bonuses. These rewards can add up significantly (free business class upgrade, anyone?), but it requires discipline and will only work in your favour if you're paying the credit card off in full every month. 

We are in our scam era, and the ploys are becoming harder and harder to spot. If you are using a debit card and fall victim to fraud, money will disappear from your account instantly and be incredibly difficult to recover. A credit card offers some element of protection against fraud in that you can dispute charges or exercise purchase protection on damaged or stolen items. In most scenarios, you'll be reimbursed without having your bank account frozen, and you can get on with your life. 

Flat tyre? Flooded apartment? Last-minute emergency? When urgent expenses arise, your credit card is your financial safety net. Use it responsibly through. Black Friday sales are not an emergency, no matter how much you think you need a second fridge or a ping pong table.

We've established there are advantages to debit and credit cards, but it's easy to make mistakes with them too. Knowing what to watch out for will help you avoid the most common traps or fix them if you fall into one.

Relying exclusively on debit cards

For those who fear debt, debit cards seem like the obvious safe choice. That's somewhat true, but you won't have any protection against fraudulent transactions. You're also missing out on building a solid credit score which you'll need when you want to make a serious purchase someday. And you certainly won't be getting a free flight to Hawaii using airmiles earned via credit card transactions.

Striking a balance between credit and debit, however, means you get the best of both worlds. The way to win is to use a credit card sparingly and pay it off in full every month.

Carrying a balance on your credit card

There's a major misconception floating around that carrying a balance forward improves your credit score. It doesn't. Paying off the full statement balance on a monthly basis is what will give you a better track record that banks can refer to when considering you for a loan or mortgage. 

Ignoring credit utilisation

This is a tricky one, so pay attention. Having a credit card allows you to build a credit score fast, and paying it off in full every month will give your rating a whole lot of extra shine. Watch out though, as using too much of your credit limit, even though it's approved and you pay it off completely, can drop your score. The recommend work-around here is to keep your spend below 30% of your credit limit. 

Overdrafting on debit cards

Debit cards are almost failproof but some banks do allow overdrafts, which means you can go into a negative balance and incur fees. Make sure you understand your options and turn off the overdraft capability if you need stricter spending guidelines. 

Not monitoring accounts for fraud

There's a fairly well-known scam that relies on people not checking their statements for transactions they don't recognise. In this example, as little as .99c might be charged to test the validity of stolen card details before the account is drained. Both kinds of cards can be compromised, so be vigilant whenever you make a payment. Check your bank statements frequently and flag anything you don't recognise, even if it's as little as .99c.

Your choice between debit and credit cards depends entirely on your financial situation and goals. Here's the breakdown.

Use a debit card if: 

• Your want to avoid debit altogether
• You're building budgeting discipline
• You're prone to overspending
• You prefer direct, simple money management.

Opt for a credit card if: 

• You want to build or improve your credit score
• You want rewards like cashback or travel perks
• You want stronger buyer protection
• You can commit to paying the full balance on time.

The smartest strategy: use both together

You don't have to choose one or the other. The most financially savvy approach is to use both cards strategically. 

Debit cards are best for everyday spending, withdrawing cash, sticking to a budget and building financial discipline. Credit cards offer protection for online shopping and are helpful for large and important purchases. Plus, you'll be collecting rewards points as you go. 

Using a mix of payment methods will help you to keep your spending under control and avoid debt while growing a healthy credit profile and enjoying the protection and perks of a credit card. It's a win-win. 

The content in this article is provided for educational purposes only. It does not constitute investment advice, financial recommendations or promotional material.