Pop quiz: What’s the difference between a credit card and a debit card? Why is it important to have access to credit? How do credit cards work?
Don’t panic if you don’t know the answers to these questions off the top of your head. We are here to introduce you to the basics of paying with plastic — and help you get started on identifying the right kind of card for you.
What is the difference between card types?
A credit card is a tool that allows you to use borrowed money to pay for goods and services. It works like this: When you’re approved, the bank hands over a hunk of credit in the form of a plastic card to use at your discretion. In swiping or dipping your credit card, you’re not using your money to pay for your groceries or a new outfit. You’re using the bank’s money, which they’ll let you do on a short-term basis without incurring any interest. At the end of the month, you have to pay that mini-loan back in full or finance charges will be assessed.
Debit cards work differently. With this type of plastic, an auto draft from your checking account is occurring when you swipe your card. You’re using your own funds to pay for your items on the spot, so there’s no borrowing involved and no bill to settle at the end of the month.
Prepaid debit cards are similar to debit cards, but with a significant twist. Instead of tapping funds in your checking account, swiping a prepaid debit means drawing on a cash deposit you made onto the card; you’ve essentially paid ahead for your purchases. As with debit cards, you’re not borrowing money from a bank when you use prepaid debit.
Why it’s important to get a credit card
To the untrained eye, it might seem that debit or prepaid debit cards are a smarter way to pay. Since they don’t involve borrowing money, there’s no way to get into debt, right?
That’s right, but using borrowed money responsibly is essential to building your credit profile. Having good credit will make it much easier for you to get loans on good terms in the future. It will also go a long way toward making other financial tasks stress-free. Examples of these tasks include renting an apartment and finding affordable car insurance. Aside from building credit, using a credit card as your primary form of payment plastic may also help you earn rewards and minimize fees, depending on the benefits of your particular credit card. Usually, debit and prepaid debit don’t offer rewards programs, and prepaid debit cards are notorious for their high (and often opaque) fees.
The bottom line
Although they look and feel the same, credit cards are very different from debit and prepaid debit cards. Using a credit card responsibly is a great way to build and maintain a healthy credit profile, so be sure to get started as soon as you can.
-Lindsay Konsko is a staff writer at NerdWallet, a personal finance website.
