Different Types of Credit & Debit Cards

Credit cards, charge cards, ATM cards, and debit cards are all ways to make purchases or get cash. But each one works differently—and these differences are important. To use these cards wisely, you should know what each one is and how it differs from the others.

How Credit Cards Work

Credit cards work relatively straightforwardly: The issuer gives you a card. You use the card to pay for items and services up to a certain amount—your credit limit. The store merchant or service provider collects what you owe from the card issuer, whom you repay.

Carrying a Balance

If you carry a balance, credit cards function like costly loans. The credit card company allows you to pay off what you owe little by little each month as long as you pay a minimum amount each time.

In exchange, you pay interest on the balance you owe—as high as 29% each year—at the end of each period.

How Credit Card Companies Make Money

Credit card companies earn high fees in several ways. They charge:

• high interest rates (interest on credit cards accounts for the bulk of the profits earned by banks that issue credit cards)
• annual fees
• late fees, over-the-limit fees, and other miscellaneous charges, and
• fees charged to merchants and service providers each time a customer uses the company's credit card in the merchant's establishment.

How Charge Cards Work

Charge cards, also called "travel" and "entertainment" cards, are a little different from credit cards. Charge cards like American Express and Diners Club have no credit limit. You can usually charge as much as you want but must pay off your entire balance when your bill arrives.

You Can't Carry a Balance

With most charge cards, you must pay off the entire balance when your bill arrives. If you don't, you'll owe a late fee. If you don't pay the amount due for two billing periods in a row, you'll typically have to pay a heftier late fee of around $35 or a percentage of the past due amount (typically around 2 to 3%), whichever is greater. Also, the creditor can cancel the card if you default.

Some charge cards allow you to pay a bill off over time. If you choose to do this, you'll accrue interest on any charges you pay over time and face a penalty APR if you don't keep up with the minimum payment amounts.

How Charge Card Companies Make Money

Charge card companies make their profits by charging high annual fees—up to about $90—and by charging merchants relatively high fees each time a customer pays using the company's charge card. Some merchants don't accept charge cards for this very reason.

How Cash Advances Work

Many people use their credit cards to get cash advances. Similarly, many credit card issuers send cardholders "convenience" checks they can use to pay for goods or services. The check amount appears on your credit card statement as a charge but is generally treated as a cash advance.

Cash advances are more expensive than standard credit card charges and have more onerous terms for consumers, including:

• Transaction fees. Most banks charge a transaction fee of up to 4 to 6% for taking a cash advance.
• No grace period. Most banks charge interest from the day the cash advance is posted, even if you pay it back in full as soon as your bill comes.
• Higher interest rates. The interest rate is often substantially higher on cash advances than on standard credit card charges.

How ATM Cards Work

Banks issue ATM cards to give customers flexibility in their banking hours. In most areas, you can use an ATM card to withdraw money, make deposits, transfer money between accounts, find out your balance, get a cash advance, and even make loan payments at all hours of the day or night.

How Debit Cards Work

Debit cards combine the functions of ATM cards and checks. When you pay with a debit card, the money is automatically deducted from your checking account.

Combo ATM/Debit Cards

Some banks issue a combined ATM/debit card that looks just like a credit card and can be used wherever credit cards are accepted. But don't be mistaken—they're not credit cards. The money you spend comes out of your checking account immediately.

Pros of Debit Cards

Many people prefer debit cards over checks for two reasons:

• you don't have to carry your checkbook and present identification, and
• you pay your bills immediately, unlike when you use a credit card and get the bill later.

Cons of Debit Cards

Some disadvantages of using debit cards are:

• Payment is immediate. Many prefer having 20-25 days to pay their credit card bills.
• No right to withhold payment. Because the money is immediately transferred, consumers using debit cards don't have the right to withhold payment in the event of a dispute with the merchant over the goods or services purchased.
• Transaction fees. Some banks and merchants charge transaction fees for using debit cards.
• High risks if stolen. If your debit card number is stolen during an online purchase, the thief may drain your bank account before you notice it's gone.

For a comprehensive discussion of credit and debit cards, along with information about budgeting and dealing with debt collectors, get Nolo's Solve Your Money Troubles: Debt, Credit & Bankruptcy, by Amy Loftsgordon and Cara O'Neill.