13
Credit Cards, Charge Cards, and Debit Cards
Yep, I love credit cards. Properly handled, they can ease your way through life. Improperly handled, they can ruin your financial life.
Howard Strong, What Every Credit Card User Needs to Know
Many things we live with, rely on, and enjoy—things such as automobiles, prescription drugs, pesticides, and candles—are intrinsically dangerous. They have the potential to harm. We would be horribly misguided if we didn’t take necessary precautions to prevent potential disaster. But that doesn’t mean they should be banished from our lives. Instead, we learn how to handle them properly and then take extra precautions so we don’t hurt ourselves and those around us.
We don’t let kids play with matches. We keep highly flammable items stored safely and choose not to decorate the Christmas tree with lighted candles. We wear seat belts, obey traffic laws, stay on the right side of the highway, and teach our kids to be defensive drivers. We lock up prescription drugs and keep harmful pesticides and cleaning products out of the reach of children.
The same is true of “plastic”—credit, charge, and debit cards. They can be highly dangerous if handled carelessly or very useful tools when we treat them appropriately and with respect.
Every adult, or family, needs one good, all-purpose, well-chosen, and equally well-managed credit card—to be handled with all the care of a highly dangerous yet powerful tool. With that privilege comes the responsibility to know and fully understand everything about the consumer credit industry and how to play its game. We need to know why the industry exists, how it functions, the designs it has on us and every member of our families, and the ways we can use that industry to our advantage.
I do not advise living completely plastic-less. That is not realistic these days. Have you tried to buy an airplane ticket or rent a car with that roll of twenty-dollar bills in your pocket? It’s almost impossible.
A credit card, by federal law, provides a number of benefits to you as a consumer. It will protect you if you use it to order something by mail, phone, or online and the item does not show up, for example. Used wisely, this tool will give you interest-free credit just long enough to transfer funds to pay a bill or get reimbursed for business expenses. But consumer credit is serious business, something that should not be considered lightly. Like a rope, you can use it to help you, or you can turn it into a noose and hang yourself. I intend to help you use it as a tool.
Why Consumer Credit Companies Exist
All consumer credit companies—whether they offer credit, charge, or debit cards—exist for a simple purpose, and it’s time we get it out in the open. They are in it for the money! There is nothing wrong with that. I am quite fond of the capitalistic, free-enterprise system myself. Still, I want to arm you with the knowledge you need to make the choice that is right for you so you can participate in this industry in a reasoned way. Then, if the powerful industry snatches a lot of your hard-earned money, you will at least know that it happened by your choice, not theirs.
Three Types of Plastic
Basically, there are three types of plastic available: credit cards, charge cards, and debit cards.
Credit cards. A credit card creates high-interest loans by allowing the cardholder to buy now and pay later, over time, with small monthly payments. Generally, there is no annual fee for a credit card, and the interest is waived if the entire balance owed is paid during the grace period.
Charge cards. This plastic carries no provision for incurring debt because it requires the cardholder to pay the balance in full each billing period. A charge card is a pay-as-you-go device, and many require an annual fee. American Express is one example of a charge card, although the company has added related accounts that allow for a revolving, interest-accruing credit balance. Charge cards are pretty much disappearing because, sadly, most people use plastic because they don’t have enough money to pay for things in cash and it’s unlikely they’ll be in any better shape a month from now when the bill comes due. A charge card requires that the entire balance be paid down to $0 each billing cycle.
Debit cards. A debit card looks much like a credit card but offers electronic access to your bank account. A debit card often doubles as an automatic teller machine (ATM) card. It is not a credit device. Your usage is not reported to the CRAs. When a purchase is made, the purchase amount is deducted as if a check had been cleared against the account.
While any one of these three choices of plastic fulfills the basic need for electronic access to funds, there are pros and cons for all three. The decision of which is best for you will depend greatly on your specific situation and lifestyle. Your needs may change with time as your financial picture changes. It is important that you know the differences among the three, the strengths of each, as well as the pitfalls.
Credit Cards
Of the three types of plastic, the credit card is by far the most widely used. More advertising and marketing schemes are devoted to credit cards, and that makes them the most complicated and difficult to manage.
More people are tripped up by credit cards than by any other type of plastic. Still, the credit card offers the wise consumer the best deal possible—all the benefits of plastic without any of the costs. To achieve that end, however, you must become adept at nibbling the bait without getting hooked.
If you—now or in the past—have had a consumer debt problem, most likely the culprit was this slick invention known as the credit card. There is a high price attached to the so-called convenience of having things now and paying for them later. According to US Courts.gov,1 there were close to 1.3 million personal bankruptcy filings in 2012, 90 percent of which were the result of excessive credit card debt. Still, the average American receives twenty credit card offers each year.
The Credit Game
When you signed that credit card application and accepted a credit card—or two or ten?—you agreed to participate in a kind of game. It is a one-on-one competition in which your opponent writes the rules. You even agreed that he could change those rules at will. Worse, your competitor isn’t interested in helping you learn how to play the game. He prefers that you remain ignorant—always paying, never questioning. Consumer ignorance drives the consumer credit industry.
The only way you can turn the tables and win the credit card game is to level the playing field. First, you have to figure out what the rules are, find out what’s in your opponent’s game book, and then develop your own winning strategy.
A credit card company’s goal is to develop each of its cardholders into a “revolver” (industry lingo for someone who carries a balance from month to month). The company’s success is found when it can get consumers hooked on credit and over their heads in debt. Credit card companies reluctantly tolerate those of us they call “deadbeats”—cardholders who always pay their balances in full and do not pay interest and fees. The practice of letting deadbeats off scot-free, however, is showing early signs of disappearing. Several companies are testing an annual deadbeat fee of $25 to $35 for cardholders who are not carrying their weight. There goes the no-fee feature if this practice is allowed to take hold.
Unfortunately, most credit card holders live in a fantasy world, choosing to believe the following credit card myths:
· Credit card companies want to make my life better.
· Consumer credit is a socially acceptable way to bridge the gap between my inadequate income and the amount of money I need to live on.
· The credit card company would not give me a credit limit I could not afford.
· My credit limit is my money. I’m entitled to spend it any way I choose.
· I trust the company to deal fairly with me, so I don’t need to understand the terms and conditions of my credit card account.
· An increase in my credit limit is a reward for good behavior. It’s a merit increase.
· It is not possible to live without consumer credit.
The Ideal Customer
Credit card companies are always looking to develop and add excellent customers. Their ideal customer is one who:
· has a perpetually revolving balance and considers that monthly payment an ordinary and necessary expense
· carries a balance that is higher than he could reasonably repay in a single month
· makes only the minimum required payment each month
· always pays on time
· accepts and then spends up to credit limit increases
No matter your debt-proof living level, whether you are in the process of getting debt-free or you are in full prevention mode, you must think of a credit card as a loaded gun—it is good to have when you need it but not something you should treat casually. You don’t make false moves, act recklessly, or treat it lightly. It is something that commands your respect.
Debt-proof living strategies are rigid when it comes to the care and use of a credit card. There’s no latitude if you intend to play the game and always win. Follow the rules without compromise and your credit card will enhance your life without out-of-pocket expense. Slip up and you’ll find yourself in a lot of financial trouble.
The DPL Rules of the Game
You need one good all-purpose credit card. The card you choose should meet the following criteria:
· No annual fee. You should not have to pay a fee to use a credit card.
· Twenty-five-day grace period. This is the time between when you use the card to rent a car, secure a hotel room, or place an online order and when interest begins to accrue. It is important to note that if you carry a balance from one month to the next, you forfeit the twenty-five-day grace period. Interest begins to accrue immediately on any new purchases added to that card.
· Wide acceptance. The card you choose should be one that is accepted in most places.
· Low interest. While it is your intent never to pay interest on a credit card because you will be paying the balance, if any, in full during the grace period, sometimes things happen. If you do pay interest, you want it to be as little as possible.
If you use a credit card, ideally you will never pay fees or interest. Therefore, the interest rate will be lower in priority when selecting a good all-purpose credit card. Most likely the card you select will be either a Visa or a MasterCard since these are accepted in the greatest number of places.
If you have multiple credit cards on which you carry balances, do not cancel those accounts at this time. The company could increase your interest rate to the maximum or even require that you pay the entire balance now. You do not want to run those risks.
Instead of closing a card you will no longer use but on which you carry a balance, close it “emotionally.” Put the card away in a place you will not have easy access to. Or go ahead and cut it up into pieces—whatever it takes for you to stop using it! When you have paid the balance in full, make a determination based on the credit score information in chapter 11 on whether to close the account. You need to keep that healthy gap between your total available credit and the total credit balances you are carrying, if any.
Once you are completely free of consumer debt, closing all but your one all-purpose credit card on which you never carry a balance or even come close to the limit during your grace period will likely improve your credit score, not lower it. Just keep in mind that closing multiple credit cards at the same time could do a number on your credit score, and not in a good way! A more reasonable way is to close one every six to eight months.
What You Need to Know
If you are now, or once were, a well-established revolver, you have been targeted by the industry as a very desirable customer. You will continue to receive unsolicited invitations, preapproved applications, and prequalified credit card offerings in the mail. There are probably three in your mailbox right now.
Every credit card account operates according to specific terms and conditions. Some of these are disclosed at the time you complete the application; others are written on the monthly statement. Never forget that what the big print giveth the small print taketh away, and that is true of both the application and the monthly statement.
If you don’t fully understand everything or information is missing, call customer service. Here’s a rundown of what you need to know about your credit card account:
· annual percentage rate (APR)
· monthly interest rate (punishment for late payment)
· punishment fee for going over limit
· grace period guidelines
· fees for cash advances
· balance transfer guidelines
· billing method basis
· statement closing date
Once you know the rules and the consequences of breaking them, you’ll be less likely to slip up. You’ll find a way never to incur late or over-limit fees and learn how to pay the least interest possible—hopefully none. Read your statement carefully every month. Scrutinize every square millimeter, and question any charge or entry you do not understand.
Take Control of the Credit Limit
It is potentially dangerous to have a credit limit of an amount more than you could reasonably repay in a single month. However, given the way you must play the credit score game, it is likely you will want a larger limit as needed to achieve a consistently low utilization rate.
It is important to note that large amounts of available credit (not debt but available credit) appearing in your credit report can be seen as a negative because potential lenders look at not only how much debt you have but also how much you could incur in a short period of time. You always have to be aware of the delicate balance you must maintain between available credit and outstanding balances, available credit and income level to ensure a good credit score of 760 or greater.
Leave Home without It
This rule applies particularly to those who are still paying off unsecured debt and those who are newly debt-free. Going back to living on credit can be so tempting at times that just carrying the card can present an overwhelming temptation to use it. Instead, keep it in a safe place—a bank deposit box or home safe. You can even freeze it in a block of ice—any place that it is safe from you.
As an alternative to carrying the card, record the number, expiration date, and toll-free number of the company (you will find this on the back of the card) in your address book or wallet. If you have a true emergency, you have what you need to get authorization by phone.
A Word of Warning
Never use a credit card to buy something because you do not have the money right then to pay for it. The credit card industry desperately wants you to adopt this mentality. For them, this is the way to huge profit margins; for you, it is financially deadly.
They want you to make the purchase today on impulse and then find you cannot pay for it within the grace period. They know (and can prove it statistically) that if you don’t have the money today, you are not likely to have it twenty-five days from now. Even if you do, once you have put that must-have purchase on credit, statistics show that you are less likely to use your cash to pay for the purchase, choosing instead to roll it over.
Let’s say you are absolutely sure beyond a reasonable doubt that you will have the money and that you will use it to pay for this purchase you’re about to put on credit. Great. So what’s the rush? Force yourself to wait the few days until you do have the money. As a bonus, you’ll give yourself the gift of time—time to think and time possibly to change your mind.
Don’t Be Late
Just because you mailed your payment on time doesn’t mean it won’t be late. Take Capital One, for example, where sorting the mail is no simple task. According to Bankrate.com, the Virginia-based credit card issuer sorts and processes anywhere from 100,000 to 600,000 customer payments each day. It takes about three hundred employees and a number of machines to make it happen.2
There are any number of things that can happen to delay your check on its journey to being processed the day it is received—if it is received. Remember, you are depending on something called the mail to get your payment to the processing center. Only after a payment is physically posted to an account is it no longer considered “in the mail.” Being late will mean a double whammy: you will have to pay interest and the late fee. It will be a triple whammy if the interest plus the late fee plus the balance puts you over your credit limit. Then you’ll get socked with an over-limit fee as well.
Setting up electronic bill pay, where your bills are paid directly from your bank account, or auto bill pay, where you give a one-time authorization and then don’t have to worry about whether your payment is made on time, is a great way to stay out of trouble. It’s safe, convenient, and cost effective. Just think of all the postage you won’t have to pay if you go electronic.
Pay Early
If you carry a balance, making your monthly payment early in the billing cycle (even before the stated due date on the billing statement) will save you money. Why? Because most credit card issuers use the average daily balance method to figure monthly interest or finance charges.
That means the big computer at your credit card company records your current balance at the end of every day in the month. Then on the last day of the billing cycle, it adds the balances for the previous thirty days and divides by thirty to get the average daily balance. That is the figure upon which you pay interest.
The schedule on the left side of the illustration shows the $400 payment being made at the end of the billing cycle, just before the due date. Payment is made on time. The schedule on the right side shows the same beginning balance and monthly activity, but the timing is reversed—payment is made early in the billing cycle with purchases delayed until the end of the cycle. That immediately reduces the average daily balance, so more of the payment goes toward the principal.
There are two reasons you should get into the habit of paying credit card bills early. First, you will avoid incurring horrendous penalties for being late if there are mail delays, and second, you’ll pay less interest so more of your payment goes to reduce the principal.
Don’t Fall from Grace
Many credit card issuers are nibbling away at interest-free grace periods. If you do not carry a balance from month to month but depend on those interest-free days, a change from a twenty-five-day to a twenty-day grace period could be very expensive. Some companies are doing away with grace periods altogether. That means that even if you pay in full, the clock starts ticking the minute you make a purchase.
Death to Cash Advances
Interest rates on cash advances can be very steep (27 to 33 percent, sometimes more), plus there’s an outrageous cash-advance fee. There is no grace period on cash advances, so the company begins charging interest the day the money is taken out. Taking into account the high interest plus the horrible fees, some issuers are effectively charging more than 30 percent for cash advances. That is ludicrous. What’s worse, most issuers now reserve the right to allocate a customer’s payment toward any portion of the balance with lower APRs. That means if you take a cash advance, it will continue accruing big interest until you get the lower APR balances paid in full. Don’t even think about cash advances on a credit card.
Watch the Mail
Credit card companies reserve the right not only to write the rules but also to change them whenever they like. Even if you have a fixed rate of interest, the law allows the card issuer to change the terms—including the interest rate—with only fifteen days’ notice. That notice may arrive on a postcard or a scrap of paper in your monthly statement. The only thing “fixed” means is that the interest rate is not tied to an index the way variable-rate cards are.
Always read your statement each month because this is where you will likely be notified of a change. Another reason to watch the mail: Your account could be sold to another company, which means you will have to abide by a new set of terms and conditions, perhaps even a different interest rate and method of determining minimum monthly payments. You will be notified, but you might think it’s junk mail. If you don’t like being sold like a slab of meat, make a call to the new customer service department (the number is given in your notification). You won’t be able to change card issuers, but you can put up a fuss and possibly negotiate new terms at least equal to those you had prior to the sale.
Know Where You Are
The worst thing you can do with a credit card is lose track of what you’ve spent and how much you owe. If you use a card (may I say that it would be better if you didn’t), get into the habit of recording every transaction the same way you record checks that you write. You’ve spent the money, so write your credit purchases in your checkbook as if you wrote a check for that amount. Include the exact amount of the purchase and deduct it from your bank balance.
Take a look at the checkbook register of one of my newsletter readers. Frank sent this to me to show me how he treats credit card purchases. Whether he writes a check or makes a credit card purchase, he records the item and deducts the full amount from his current balance.
When Frank receives his monthly credit card statement, he matches it to his checkbook. In this example, Frank verified that the eight purchase amounts totaled $346.48—the exact amount his card company said he owed for the month.
Notice that on May 13, after he made sure all the transactions he was charged were correct, he wrote “Visa Total” and entered $346.48 as a credit. He had to do this reverse action so that when he paid the Visa bill in full by writing check 106, he didn’t end up deducting his credit card purchases twice (simply a debit/credit function required to make everything balance).
Of course, when Frank receives his monthly checking account statement, he will need to ignore all Visa entries—both debits and credits—he’s made to manage his credit card use, but that should be simple to do. Then he can reconcile his bank statement without a problem.
There’s something important about writing down credit card transactions as they occur. It’s called reality and keeps you from slipping into denial.
Specialty Credit Cards
Among the hundreds of credit cards available, there are two specific types we need to discuss: affinity cards and rewards cards. Both types of cards usually require annual fees, and that pretty much puts them out of the running to qualify as the one good all-purpose piece of plastic you need to own.
Affinity cards. Affinity cards are marketed to a group of customers with a common bond, such as membership in an organization. You might have a credit card issued by your college alma mater for example. Typically, a small portion—emphasis on the word small—of the fees you pay to the credit card company for your affinity card goes back to the organization. You are not going to find a no-annual-fee affinity card. If you justify the fee by saying you are supporting the organization, you are really fooling yourself. You’d be better off to stick with a no-fee card and send the organization a donation occasionally.
Rewards cards. These are probably the most misunderstood of all credit cards. Consumers are often willing to pay annual fees and make frequent use of the card because they believe they are getting paid to do so. The most popular of the rewards cards is Discover card, which has no annual fee and rebates 1 percent of annual purchases. Here are my objections to the Discover card method.
First, Discover is not a card I would classify as being accepted in most places, so it doesn’t meet that criteria of an all-purpose piece of plastic. Second, if 1 percent of your annual purchases is significant, you need to rethink why you are putting so much stuff on a credit card throughout the year. Statistics prove that you will spend at least 23 percent more simply because you have the credit card mentality when it comes to paying for things.
The second most popular rewards card is one that earns frequent flyer miles. Cards that earn miles almost always charge a significant annual fee of $50 to $85 or more. Here’s the problem. You get one mile for each dollar you charge to your credit card. It takes a minimum of 25,000 miles to get one round-trip airplane ticket, and even that comes with a lot of restrictions. You have to put $25,000 of purchases on this single credit card to get enough miles to do anything with them. That means each dollar you charge on that card is worth one cent toward a plane ticket. By that calculation, one round-trip ticket is worth $250. That’s a pile of required charging just to get a $250 benefit (remember, you had to pay at least $50 just to get the credit card), and that’s assuming you will rack up $25,000 in credit card purchases in a twelve-month period. The companies involved know for certain you will tend to justify charging in order to collect miles.
Another problem is that often the miles expire—you don’t have an unlimited time frame in which to redeem them. This is a marketing ploy designed to create a sense of urgency. Of course, each situation varies, but typically the miles expire after two or three years. The cardholder who is paying $50 to get something for nothing now must also charge at a high rate in order to collect enough points to turn this rebate fiasco into something useful.
I recommend that unless you earn miles by traveling a lot in addition to putting the cost of said travel on the rewards card (meaning you travel at least 50,000 miles a year on the same airline), you are far better off to go with a no-fee, non-reward card and then shop for good airfare deals when you do want to travel.
The rewards card industry is growing and changing on a daily basis. Just remember that when all the smoke clears, the reason for the rewards plan is to increase the credit-granting company’s bottom line—not yours. They are not in business to give you free gasoline or free plane tickets or a rebate check at the end of the year. They are in business to turn a huge profit, and if returning a minuscule portion to the customer is the way to do it, that’s exactly what they’ll do. It is not reasonable to think these companies would give away more than they receive.
If, in spite of everything, you are able to make a rewards program work for you, and you are not incurring debt to get the rewards (it can be done—I’ve seen it from time to time), bless you. Just remember that the company is banking heavily on the statistics that say one day you’ll charge more than you can repay in a single month, and then they’ll cheer because they have you as an interest-paying customer.
Charge Cards
A charge card differs from a credit card in the following ways:
· There is no stated spending limit.
· The balance, if any, must be paid in full within thirty or sixty days, depending on the charge card (which can be thought of as interest-free credit). There is no rollover privilege or opportunity for debt on a charge card.
· There is an annual fee of $55 to $300, depending on the card.
Because of the strict limitations, a charge card is simple. You charge; you pay in full when the statement arrives. It’s difficult to play games with a charge card. Without a purchasing limit, one might fear going nuts in the first month or two and spending beyond one’s ability to pay in full. If that happens, which surprisingly is not that common, it won’t happen again. The card will be canceled, and the cardholder will quickly learn a difficult lesson.
One drawback with a charge card is the lack of choices. American Express charge cards, Chase Ink Bold business, and Diners Club are becoming relatively rare among American consumers today. Another drawback is the fact that American Express is still not accepted as widely as Visa or MasterCard.
Debit Cards
Debit cards are issued by your bank and are tied to your bank account. Most debit cards double as an ATM card, and banks have gone to great lengths to replace all generic ATM cards with Visa- and MasterCard-branded debit cards. It is to the bank’s or credit union’s advantage to have its customers swiping debit cards all over town. They want to become involved in every consumer purchase, not just the larger ones that consumers have been trained to pay for with a credit card. Debit cards allow banks, credit unions, Visa, and MasterCard to get in on the little purchases too, provided they can train their customers to use the debit card for those smaller purchases.
Swipe fees cost merchants, who must pay the debit card’s issuing bank. But in the end, it’s the consumers who pay when merchants raise prices to cover swipe fees. New legislation (as I write, some laws are pending while others have been recently enacted) means that banks are making less off retailers (12 cents per swipe instead of 21 cents), but they’ll turn to consumers to make up for it. Think more expensive bank accounts, higher debit card fees, and higher minimum balances.
Two Ways a Debit Card Works
There are two types of debit transactions, and both are housed in the same card. Your old ATM card limited you to online, also known as PIN-based, transactions at some gas stations and grocery stores that had PIN machines where you would punch in your secret code. Then, as if by magic, a new debit card showed up in the mail with either a Visa or MasterCard logo on it and you discovered you could use it to buy things just about anywhere that Visa and MasterCard were accepted.
If you have a debit card with a Visa or MasterCard logo on it (and if things are not confusing enough already, Visa calls it both an ATM card and a Visa check card, and MasterCard calls it a MasterMoney card), there are two types of transactions you can make with it: debit (PIN-based) and credit (signature-based).
When paying for a purchase, the clerk will ask, “Debit or credit?” When you reply, “Debit,” it becomes a PIN-based transaction. You are required to enter your personal identification number (PIN) after the card has been swiped. With PIN transactions, funds are withdrawn from your checking account immediately at the time of the transaction. When you reply, “Credit,” it becomes a signature-based transaction. Signature transactions do not require your PIN, but you must sign a slip to accept the transaction.
With signature transactions, funds are held in your checking account until the transaction posts to your account in one to three days. The only thing a signature-based transaction (the one that happens if you reply “credit” when using a debit card) has to do with credit is that it is processed in the same batch of transactions as those made with credit cards.
Banks are pushing the use of debit cards because the transactions are cheap to process. It costs a bank five times more to process a paper check than a debit card transaction. As banks convert customers to debit cards, they reap huge profits on overhead savings alone.
Merchants love debit cards too. Even though they pay a fee every time a card is swiped, they do so willingly because they know a customer who shops with plastic impulsively spends more than one using old-fashioned cash or even a checkbook.
A Visa- or MasterCard-branded debit card looks just like a credit card and works like one wherever those cards are accepted. The merchant or retailer does not know the difference. You can purchase an airline ticket with a debit card provided you have the cash in the bank to cover the purchase. A debit card will also work to rent a car at most places with this specific warning: The agency is going to place a hold on the account for at least $500. This means you will not be able to go below this amount in your checking account until your rental car tab is settled. That could ruin your trip and cause a lot of checks to bounce if you’ve not properly prepared.
A debit card differs in several significant ways from its cousins, the credit and charge cards.
There is no annual charge for a debit card; however, some banks charge various use fees. Be sure to check the details of all charges and fees should you select a debit card as your plastic of choice.
Unlike a credit card or charge card, a debit card does not enjoy the same protection against theft or fraudulent use. With a debit card, you are responsible for a maximum of $50, provided you report the loss or fraudulent charges within two to four days. If you wait longer, you could be responsible for up to $500. If you don’t notice anything wrong until after sixty days, the total of your loss would be your responsibility. These provisions seem to vary from card to card, which only adds to the confusion. Check with your own issuer to learn the specifics of your fraud protection, if any.
Debit Card Hazards
There is a hidden danger with a debit card that has the potential of wiping out its benefits: Banks do a hard sell for an overdraft protection feature when a debit card is attached to a checking account. This protection provides that in the event the account holder overdraws the account, the overdraft is automatically covered by a draw against a line of credit. Of course, the bank makes this sound like wonderful protection for the account holder. While it will prevent the embarrassment of bouncing a check, it is a sneaky way to get the customer to incur debt.
Overdraft protection does not simply cover the exact amount of the overdraw. Rather, the bank dumps money into the account in increments of, say, $200. Because this is actually a cash advance, interest accrues immediately and at a hefty rate. Plus, the penalty fees for overdraft protection can be significant.
Suppose you have $150 in your checking account. You find a terrific sale the same day you have haircut appointments for the family. You swipe your debit card a couple of times to the tune of $151 for the day. What’s a buck? you reason (if you even realize what you’ve done). That is not, however, the way the big computer in the sky looks at your misdeed. Without flinching, your overdraft protection feature sends $100 to your account, and you begin paying interest at that moment on the entire $100, not just the $1 you needed to stay above water. Considering the fees, interest, and the possibility that you’ll go ahead and spend the rest of the $100 rather than pay it back immediately, that could be the most expensive $1 you ever spent.
Human nature being what it is, most people will not immediately go through the steps necessary to pay back the entire $100. Believe me, financial institutions count heavily on human nature. I have actually received letters from people who swear they have no unsecured debt, all the while failing to see the $4,000 balance on their overdraft protection account as exactly that: a pile of debt! I can only conclude that overdraft protection has some kind of virtuous ring to it, and consumers pride themselves on paying dearly for this kind of insurance.
Some banks now allow customers to overdraw their accounts using an ATM machine. The machine knows you have no money in your account; however, it is set to allow you to make a withdrawal, and the moment you do, you are slapped with an overdraft penalty—and without notification.
The Trouble with Debit Cards
True or false? A Visa or MasterCard logo on your debit card means you have the same consumer protection as you do with a credit card. If you answered true, you are wrong. The basic difference between a credit card and a debit card is in the way it works, not the way it appears (remember, debit cards are designed to mimic credit cards in appearance).This is important, so read it carefully. If the money comes directly out of your bank account each time you use the card, it’s a debit card. If you get a monthly statement from your issuing bank listing your transactions and showing how much you owe, it is a credit card.
Credit cards are regulated under the Fair Credit Billing Act, a federal law that protects consumers against unscrupulous merchants and card thieves. Consumers can dispute charges and even refuse to pay if a merchant is unwilling to make good on its goods or services.
Debit cards, on the other hand, are regulated under the Electronic Funds Transfer Act, a weaker law that does not confer the same level of protection.
Some banks, and even the MasterCard and Visa organizations, offer consumer protection plans (for example, they will replace the money in your account if a thief somehow gets ahold of your PIN and steals money from you), but these are voluntary and can be withdrawn at any time. They are not required by law to do this. And debit cards do not carry other protections that credit cards must by law.
Let’s say you buy an airline ticket. The airline goes bankrupt before you make the trip. If you paid with a credit card, your credit card issuer takes the hit and credits back to you the cost of the ticket because it failed to deliver to your satisfaction the goods or services you paid for with that credit card—not because they think you are such a great person and want to help you out but because they are required to by federal law.
But if you paid for that airline ticket with a debit card, you are out of luck. You paid for it with your money, so now it is you against the airline. Sure, you can file a claim through bankruptcy court and stand in line with all the airline’s other creditors. But, believe me, you’ll be way, way, way at the back of the line.
What if a crook gets your card? If it’s a credit card, you’re protected. You report the theft, your account is closed (the law says you pay the first $50, but most credit card issuers waive that), a new account is opened, and the theft—no matter how large—becomes the credit card company’s problem.
But if your debit card gets into the hands of a crook, the entire contents of your bank account are at risk. If you notify the bank in a timely manner (the law says not later than two days), it must rectify the mistake or not charge you for withdrawals made by someone else. But here’s the kicker: You must prove it wasn’t you. That can be difficult if the perpetrator used your card number and PIN to clean you out. Or went on an online shopping bender.
The idea behind a debit card is a good one. It’s a convenient way to pay without creating debt. But there are other ways to do that. Write a check, pay with cash, or in the case of a major purchase in which consumer protection may become an issue, use a credit card. Paying the balance in full to avoid going into debt will not forfeit your protection under the law.
If you feel you must have a debit card:
· Have your debit card account at a bank or credit union where you have no other accounts. Keep the balance low to limit your exposure to fraud.
· Watch your account closely and report any problem immediately. Remember, a thief doesn’t need your card, only your name, address, card number, and expiration date to go on a shopping spree.
· Limit your debit card use to minor purchases such as groceries, gasoline, etc. Use a credit card for major purchases and anything that involves a promise to deliver such as an online transaction or a mail-order purchase. You’ll be protected if something goes wrong.
The Right Plastic for You
Each type of plastic—credit cards, charge cards, and debit cards—has its own pros and cons when it comes to owning one good all-purpose piece of plastic. When making the decision, you should take into account your current and specific situation.
If you are not yet debt-free but are aggressively working on your Rapid Debt-Repayment Plan, you would probably be better off sticking with whatever you have until you become debt-free. At that time you can reassess your situation.
A charge card has a decided benefit for the person who carries no debt but feels insecure about inviting temptation. If you don’t want to deal with the temptation and don’t mind paying an annual fee to be freed from it, a charge card might be the best way for you to go.
It is possible to turn any credit card into a charge card provided you exercise the discipline outlined in this chapter’s credit card rules. You must repay the entire balance, if any, during the grace period and never incur fees or interest. Exercise this kind of personal discipline and financial maturity, and you will have the best of both worlds: the benefits of plastic with no annual fee and no interest charges.
There was a time, and not that long ago, when I would have scoffed at the person purposely choosing to pay an annual fee for a charge card. From time to time, readers would write and tell me they carry an American Express card and willingly pay for it because it keeps them on the straight and narrow. The balance must be paid in full every month; there is no other option. My reply was always curt yet playful. For half the fee I’d be happy to babysit them and apply all the pressure needed to make them pay the balance in full during the grace period if they would switch to a no-fee credit card.
But things have changed drastically in the past few years. Credit card companies have pulled in all the slack. While in the past one could be even fifteen days late with a full-balance payment and not incur penalties, such a slipup today comes with a hefty late fee and interest on the full amount. Even the most straight-shooting consumer is human. Things happen. It is very easy to slip up and end up paying far more than the $55 annual fee on a charge card.
So I admit to having a change of heart. I believe that for many people the freedom from worry of a slipup might just warrant the fee required for a charge card. It certainly eliminates many hassles.
Debit cards are by far my least favorite type of plastic. The fraud protection is, at best, shaky. But beyond that, there is the temptation to use a debit card with a certain level of abandon—to purchase everything under the sun by swiping instead of writing a check or using cash. It becomes far too easy to empty your bank account than if you actually had to write out the checks and think about what you’re doing. I would rather see you use a credit card or charge card as outlined above than to choose a debit card.
Obtaining Your Card
The following should help you locate whatever type of card you choose.
Credit cards. To find a current list of no-fee and low-interest credit cards, visit IndexCreditCards.com.
Charge cards. For an American Express Green Card ($0 introductory annual fee for the first year, then $95 a year), go to AmericanExpress.com. For Chase Ink Bold ($0 introductory annual fee for first year, then $95 a year), see creditcards.chase.com. Information on Diners Club (annual fee of $95 a year) can be found at DinersClubUS.com. If you go with a charge card, select the American Express Green Card. Don’t let your ego lead you astray into gold or platinum status. For no additional benefit, you will have to pay a much higher annual fee.
Debit cards. Contact your bank or credit union if you do not already have a Visa- or MasterCard-branded debit card but have decided this is the best choice for you. Treat your debit card with all the respect of a credit or charge card and you will not fall into the temptation of seeing it as easy access to your cash in the bank.
The Do-It-Yourself, Consumer-Protected, No-Fee, Hassle-Free, Totally Brilliant “Debit Card”
What if I told you there is a way you can have a fully functional debit card without any of the problems and hassles mentioned above. You’d say, “Mary, this is brilliant!” Well, get ready because that’s exactly what I have for you.
Step 1. To do this, you need a credit card with a $0 balance. This should be a MasterCard or Visa that has no annual fee.
Step 2. Transfer money into this account. Do this by check or online as you would if you did have a balance and were simply sending in the money to pay it off. This will result in your account showing a credit balance. If you send in $500, you will see a credit balance of -$500 on your next statement or online when you check your account.
Step 3. When you shop online, at a store, or visit a restaurant—anywhere you normally depend on your debit card because the money comes straight out of your bank account—use this DIY “debit card” instead.
Step 4. In two or three days, the amount of your purchase will show up on your account as a charge. Your credit balance will be reduced by that amount with no fees or additional charges. If your purchase was for $3.73, your $500 credit balance will be reduced accordingly to $496.27.
Step 5. Watch your account as you would any account. If you see a fraudulent charge, you have all the protection of federal law that regulates credit cards. Call customer service.
Step 6. When your credit balance runs low, deposit additional funds.
Step 7. If you need to get your credit balance refunded, call customer service with your request. By law, they must send it to you in full within seven days of your request.
There you go. And, yes, it is brilliant.