Eli5 can someone explain debit and credit cards and why and when to use one or the other
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Debit cards make transactions from your bank checking account, you can direct deposit your work check directly into your account and it’ll be in your checking account a couple hours after 12am of every pay day, though it may differ depending on banks and employers.
Credit cards make transactions from a credit line, all lines of credit come from banks but banks often partner with retailers and businesses to distribute more lines of credit, for example you can get a credit card from Best Buy but the actual credit line comes from Capital One bank. Credit lines are essentially what the bank offers to lend you, if you make a credit line with no credit history you’ll likely get approved for about 200-400 depending on your bank of choice, the bank is now agreeing to lend you up to the amount which your credit line is good for, say $300, and charges interest on the remaining balance at the end of the billing cycle. So if you owe $100 on a credit line which bills on the 29th for 10% interest, your credit line will now have a balance of $110 the day after your billing cycle ends. You don’t want to have your credit card be charged this interest however because it will cause a negative credit report to be sent to the credit agencies, who evaluate your ability to pay back debt and compile your credit score. You ***DO*** want to use your credit card for basically everything so long as you know that you can pay it back, because if you do then the bank will submit a positive credit report and your credit score will rise accordingly.
There’s only 3 instances in which you should use your debit card over your credit card:
1. You are withdrawing money, credit lines usually have a lower cash credit limit than their maximum allowance, so say again if you have a credit line that’s good for $300 you can probably only withdraw $200 from it as “Cash Credit.” They usually also come with heftier fees for withdrawing money than checking accounts do.
2. You don’t believe you will have enough money at the end of the billing cycle to pay back your balance. Not paying will result in a negative credit report and consistently missing payments will deem you untrustworthy to lenders and investors, making it almost impossible to do seemingly basic things like be approved for an apartment lease.
3. The transaction is large enough that it leaves you at a bad Credit Utilization Ratio (see below)
***ADDITIONALLY NOTES*** you will receive a positive credit report no matter how quickly you pay off the balance, you can use your credit card and then immediately transfer money from your checking account to your credit line, at the end of the billing cycle the bank will see that you used your credit line and payed it off and so they will submit a positive credit report. It doesn’t matter if you pay it back immediately or if you pay it back at the very end of the billing cycle, the effect is the same.
HOWEVER, it is best to pay it back immediately because of one reason, banks can submit negative credit reports even if you pay off your balance before the billing cycle, this is because you used too much of your credit line. If you have an allowance of $1000 and a balance of $800, you are using 80% of your credit line, this is too close for comfort for many investors, you should always try to make sure that you don’t use more than 30-40% of your credit line. This is referred to as “credit utilization ratio” and it’s one of the biggest things that screws people who pay back their balance, they used too much of their allowance and ended up with a bad credit utilization ratio during their billing cycle.
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