Don't Use Debit Cards

I talk to a lot of people who tell me they don’t need or want a credit card because it’s just easier to use a debit card for purchases, or they are worried about credit card interest. They are all wrong.

Let’s consider the following scenario: You are paid $1500 every two weeks, directly into your checking account, you have a debit card for that account, and you have a credit card with no annual fee that charges you 20% APR on any balance you hold after a 30-day grace period each month (fairly standard credit card terms).

Now say at the beginning of the month you get your $1500. In the first week you end up spending $1300 because you had to buy a plane ticket to Tokyo. In the second week you end up spending $205 just on normal stuff like coffee and lunch and drinks after work. And just for the sake of argument let’s assume you spend $250 in each of the third and fourth weeks, after you’ve received another $1500.

If you are using a credit card you get a bill for $2005 at the end of the month and have 30 days interest-free to transfer the money from your checking account. You pay no fees, and no interest, assuming you pay off the balance within 30 days of receiving the bill. That shouldn’t be a problem since you’ll have $3000 sitting in your account by the end of the month.

But if you are using a debit card, you overdraw your account once in that month and have to pay the $30 (e.g.) overdraft fee. Not to mention you were probably stressing out a lot of the time, knowing that you were nearly out of money and wanting to avoid the overdraft charge. The $30 charge is effectively an interest rate, and it’s much higher than the 20% APR you’d pay carrying the same balance on your credit card. Even if you’re only overdrawn for one day and for $1 you pay that flat fee.

Consider this. You overdrew your account by $5 for a couple of days and were charged $30 (maybe two or three times more, if your bank “conveniently” tries to put the final charge through again). So you borrowed $5 from your bank for a couple of days. At 20% APR it would take almost ten years to accrue $30 in interest carrying a $5 balance on your credit card! Your bank is charging you that much interest just for a couple of days! And they’ll do it again and again if you’re not careful to keep your balance positive.

Generally this leads most people to leave a bunch of extra money in their checking accounts so as not to risk overdrawing. Checking accounts earn zero interest generally, so this effectively costs people the interest they could otherwise have earned putting their money to work somewhere else. Even if you never overdraw your account there is still this implicit cost. Granted it usually isn’t very much money you could have otherwise earned, but it’s something.

So don’t use debit cards. Use your credit card as a cashflow management tool. It’s completely free if you pay off your balance before the grace period ends. And even if you don’t, the interest you’ll pay is much much less than you’d pay your bank when you overdraw your account.