The UK’s debt problem continues to grow and consumer helplines such as Stepchange and National Debtline are expressing their concern as borrowing on credit cards, loans and overdrafts reached £1.25bn back in November last year; the highest for nearly seven years. Chief executive of Stepchange, Mike O’Connor, said that there is ‘a worrying rise in people’s reliance on credit. The economy is growing and there is some wage growth but it is very marginal and millions are living on a financial precipice leaving them vulnerable to financial shocks and strains. The prospects are for more austerity and economic prospects are uncertain. People may turn to credit as the only accessible way to try and plug the gap. If and when we see an interest rate rise, many more people will struggle.”
The UK credit card industry is worth £150bn and as banks and credit card companies fiercely compete to attract new customers, balance transfer deals on credit cards have become more and more generous and consequently more appealing. Credit cards are not all bad news and they certainly have their place in our purses, but when is it best to use a credit card and when should we be using a debit card instead? Firstly, let’s take a look at the difference between a credit card and a debit card:
Debit cards are linked directly to your bank account. When you pay for something in a shop, online or use it to withdraw money from a cash machine the money is automatically taken from your current account. The amount you can spend or withdraw on it relates to the amount of money you have available in your account or to an agreed overdraft limit. You will not be charged interest, unless you go over the overdraft limit.
Credit cards are separate to your current account and allow you to spend money up to a limit that has been agreed with the credit card company or bank. You are borrowing money with the understanding that you will pay the balance off at the end of each month when you will receive a bill. If you don’t pay the whole amount off by a set date, interest will be added meaning the quicker you pay off the balance the less interest you will pay. Some credit transactions involve the merchant having to pay a credit card transaction fee, which will either result in higher prices or a minimum purchase requirement.
There are advantages to using both types of cards and it is always handy to have both, but there are also disadvantages and times when it is more financially beneficial to use one type over the other.
It is best to use a credit card when:
- Shopping online – Using a credit card to pay for your online purchases is without doubt the safest option in terms of covering you for any fraudulent charges. Credit cards are also covered by the Consumer Credit Directive, which means should you buy something that is not fit for purpose or is broken, both the card provider and the supplier are liable.
- Making large purchases – Many credit cards offer warranty protection on your purchases, which in some instances can include more than the warranty that is provided by the manufacturer. This is especially useful for electronic items and appliances.
- Travelling abroad – The anti-fraud protection that is offered by credit cards is crucial for offering you peace of mind when you are travelling abroad. If someone were to steal your card or you inadvertently use a dodgy ATM machine, you can put a stop on the transaction without being liable for any charges. Any reputable credit card company will know your spending patterns and it is highly likely that they will notice a fraudulent transaction, however if they don’t notice anything you will still be protected when you realise yourself.
- You want to improve your credit history – If you are looking to establish or re-establish a good credit history, taking out a new credit card and using it responsibly i.e sticking within limits and paying the balance off each month, will increase your credit card rating. This in turn will improve your chances of better credit terms, such as low interest rates, low fees etc, for any future loans you may need.
- You want to earn cashback – If you pay off the balance each month, you could earn cashback on the purchase you make on your card. The current market leader is the MBNA American Express card, which offers cashback of 1.5% on purchases made at petrol stations and supermarkets as well as 0.75% on all other spending. Two other examples are the MBNA Visa card, which offers cashback of 1.25% on fuel and supermarket shopping and 0.75% on other spending or the American Express Platinum card, which offers 5% cashback on purchases up to £2,000 in the first three months.
- More flexibility – Some hotels, airlines and other travel based companies will insist on credit cards for any reservations or bookings that you make. You won’t necessarily be expected to pay with a credit card, but they will want it as security.
- You want to get discounts, vouchers and rewards – Some credit cards will reward your custom and loyalty with special discounts, shopping vouchers or other points schemes. The current market leader of this type of system is the Marks and Spencer credit card, which rewards you with one point for every £1 that you spend at Mark and Spencer or for every £2 that you spend elsewhere. When you reach 100 points you earn a £1 reward voucher. Some credit cards allow you to earn air miles and money off of motoring costs.
It is best to use a debit card when:
- Payments are needed immediately – Debit transactions are the fastest method of payment, other than cash, as they are handled almost instantaneously.
- You’re sticking to a budget – If you haven’t got the money a debit card won’t let you spend it, so there is no fear of getting into debt, you simply learn to live within your means.
- You are not good at handling your money – If you are someone who has a bit of a shopping habit, struggles to say no and generally has a hard time managing what money you have, then a credit card is a powerful tool you would be best off without. Keeping just a debit card in your purse instead would ward off any frivolous spending temptation as you can only spend what you can afford. Some banks offer a zero liability policy on their debit accounts, which means you would be protected against any fraudulent activity in much the same way as you would be protected by a credit card.
- You want better exchange rates on foreign currency – Although credit cards are generally better for any transactions you make when you are abroad, getting money out of a foreign ATM is best done by debit card. This will entitle you to a better rate of exchange and will avoid any fees that may be associated with credit cards.
- You withdraw cash – If you use a credit card to withdraw money from an ATM it is likely you will charged a fee, whereas if you do it with a debit card the process is free.
As you can see, there really are pros and cons for both type of payment card and the decision of which one best suits you will vary with each individual. You should base your choice on what you spend most of your money on, how safe you feel using a particular card, the agreements a bank or credit company can offer you and indeed on what type of spender you are. Ask yourself whether you can be trusted with a credit card and whether you have the money to pay the balance each month?