When the financial crisis started, one of the causes was identified as the huge credit card debt people were holding on their cards, and many experts were of the opinion that, one way for people to control their spending was the use of a debit card. The advantage of a debit card is that one can only spend what is in the bank, and not money you expect to earn in the future. But just because debit cards have this advantage does not mean they don’t have their short comings. Sarah Morgan explains in the following article some of the pitfalls you need to look out for when using a debit card.
For some consumers, debit cards represent a safe, budget-friendly alternative to credit cards, offering the convenience of plastic without the risk of racking up huge debts. However, debit cards also are used most often by consumers who can least afford to make financial mistakes — and they are not without pitfalls.
Although debit card use is increasing among consumers with high credit scores, subprime consumers still use debit cards much more often than those with excellent credit, according to a recent market research report by MasterCard (NYSE: MA – News). Consumers with FICO scores below 650 use debit cards 28 times a month, compared to 11 times for those with scores above 720.
Many of these debit-card users may not have the option of using a credit card, particularly as lending standards have tightened following the recession and the credit crisis. Consumers who aren’t certain they’ll use a credit card prudently are right to steer clear because those who slip up face steep annual interest rates, says Bill Hardekopf, the chief executive of LowCards.com.
Still, credit cards offer many advantages over debit cards, and as consumer protections outlined in the Credit Card Accountability, Responsibility, and Disclosure Act of 2009 take hold, more people may come to adopt the responsible use of credit, says Curtis Arnold, the founder of CardRatings.com.
For now, consumers with low credit scores or precarious finances may continue to lean on their debit cards at some risk. Here are five tips for struggling consumers using debit cards:
Watch the Calendar
Consumers living from paycheck to paycheck should be particularly careful about keeping track of each month’s bills to make sure small debit card transactions don’t add up to bigger trouble.
Setting up a cash-flow calendar of regular deposits and bills can help illustrate when money is likely to be tight, says Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling. Consumers can also call creditors and ask for the due date to be changed on a loan or a credit card with particularly inconvenient timing, Cunningham says. The change might mean paying a small amount in extra interest one month, but the cost can be worthwhile if it helps ensure on-time payments in the future, she says.
Keep a Close Eye on Your Account
Consumers who share a joint checking account with a spouse or partner “have to be especially vigilant,” says Gerri Detweiler, a credit advisor for Credit.com. “Make sure you’re in frequent communication about the purchases made on the account,” Detweiler says.
Consumers who rely heavily on debit cards should also regularly check account balances online to watch out for fraudulent activity, Cunningham says. In the case of fraud, “you ultimately get your money replaced, but that gap time can be very damaging to your credit report” if a consumer misses another bill payment while waiting for an account to be restored, Cunningham says.
Be Aware of Holds
Many hotels, rental car companies, and gas stations will place a temporary hold on a card for an amount greater than the actual cost of the transaction. These holds are “a big problem for a lot of debit card users, particularly if you run a little close on your balance every month,” Arnold says.
Avoid the Overdraft Trap
As of Aug. 15, a new Federal Reserve rule prevents banks from charging overdraft fees unless consumers specifically opt in to overdraft “protection.”
In the past, a small number of struggling consumers have generated the bulk of these fees, with 16% of account holders paying 74% of fees, according to the Center for Responsible Lending.
As the Aug. 15 deadline approached, banks appeared to be targeting those frequently overdrawn consumers for expensive overdraft protection services, according to the Center’s research. Consumers should be aware that there are cheaper options that still won’t result in rejected debit card purchases, including linking a checking account to a savings account, says Charlene Crowell, a communications manager for state policy and outreach at the Center.
Rebuild Credit Scores
Using a debit card won’t help a consumer with a low credit score rebuild a strong credit history.
“If you’re using debit cards because your credit is shot I do think it’s a good idea to get a secured card,” Detweiler says. Consumers using a secured card to rebuild their credit should make sure that it reports to all three major credit bureaus, she says. If possible, look for a card where the security deposit can earn interest to help make up for taking that money out of savings, Arnold says.
Consumers with extremely low credit scores (below 600) should know they could be rejected even for a secured card, Arnold says. Having another relationship with a specific bank could help win approval, he says. However, getting rejected for a new card will be yet another hit to that struggling consumer’s credit score.