It’s one of those questions that we don’t often think about, but has a larger impact than you may realize. Last week, I talked a lot about credit, particularly about what the nature of credit is and how banks use credit scores to determine someone’s credit worthiness. In short, credit means debt.
The question “Debit or Credit?” is really asking how are you paying for this transaction, on a debit card, or a credit card?
A debit card is linked to your checking account. In theory, you can only use a debit card to spend money you actually have. Depending on your bank and your account settings, you may or may not be allowed to overdraft on a debit card. Now as we’ve learned, banks are in business to make money for themselves. What they call “overdraft protection” isn’t protecting you, the consumer. If you enable overdraft protection, your card will allow a transaction to go through, even when there’s not enough money in your account to pay for it. For offering this “service” the bank will charge you a fee, typically in the range of $30 PER OVERDRAFT. (I found this cool nerdy article comparing the overdraft fees at different financial institutions.) Now not only have you spent all the money in your bank account, you’re paying a service fee to do so. Some banks default to enabling this feature, so the consumer has to go into their account settings and choose to disable it.
Disabling overdraft protection doesn’t guarantee that your account won’t overdraft, as checks and auto-withdrawals are typically still allowed to go through. Now, let’s say for example that you start the day with $50 in your bank account and you make two transactions. An auto-payment clears for $40, and you buy $60 dollars worth of gas. The bank is not required to let the $40 go through first. Instead, the $60 in gas can go through and charge you an overdraft fee. Then, the $40 auto-pay can go through charging you ANOTHER overdraft fee on the same day.
This Forbes article estimates that Americans paid $34 Billion in Overdraft fees in 2019.
There are ways around overdraft fees. Some banks will allow you to auto-pull from another account such as a savings account, or waive the fee if you transfer money into the account before the end of the business day.
Despite all of this, the biggest impact of choosing Debit or Credit has nothing to do with the consumer. If you pay with a credit card, the bank gets to charge your merchant a higher transaction fee than if you pay with a credit card. While based on a percentage of the transaction, the Federal Reserve reported that the average transaction fee for prepaid cards and debit cards was $0.24, and the average for credit cards was $.54. In general, swipe fees on Visa, Mastercard and Discover range from 1.5% to 2.5% of the transaction. For American Express, it’s more like 2.5% to 3.5%. Small business can typically pay 1%-2% higher rates than these due to a lack of negotiating power. This can result in as much as a $5 charge on a $100 transaction. A pretty steep cost of doing business, and part of the reason small business often struggle!
Banks incentivise consumers to use credit cards with rewards programs, giving you back a percentage of your spending. However, even if you’re paying with a debit card and choose “run as credit”, the bank makes the higher transaction fee, so now the rewards systems are incentivising the consumer on debit card purchases as well. These rewards systems are the banks giving the consumer back a tiny sliver of the profit they’re making on your transactions.
So why should you as the consumer care about how much a business pays in transaction fees? Do you have any obligations to try and pay on a debit card? There’s two examples I can think of where it’s beneficial to the consumer to try and pay with debit cards. The first is when you want to support a local business. Choosing Debit instead of Credit can help keep their costs lower and keep your favorite niche in town. The second is that these charges don’t live in a vacuum. Any fees a business can’t absorb will be passed back down to the consumer through an increase in the cost of the product or service they’re purchasing.
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