What is a Debit Card and How Does It Work?

Spending money today looks slightly different than it did years ago. Seemingly gone are the days of cashing a paycheck at the bank and using your physical money all week long. With direct deposits delivering funds directly to your bank account, you now have choices when it comes to spending.

Using plastic, in the form of debit or credit cards, is a more secure way to pay for purchases online or in person. And while debit and credit cards may look eerily similar, they serve different needs.

Creating an effective spending strategy means learning to use debit and credit cards in tandem. And to properly do so, you’ll need to understand how they work and how to choose the right debit card for you.

In this article, we’ll cover:

• What debit cards and credit cards are
• The future of debit
• The pros and cons of debit and credit cards
• How to choose a debit card

How Does a Debit Card Work?

A debit card is provided alongside a checking account as a way to make purchases. Formerly a check card, a debit card is appropriately named for the debit transaction that reduces funds in your account following a purchase.

Not to be confused with an ATM card that only enables you to withdraw funds from an ATM, debit cards are backed by a major payment processing network like Visa or Mastercard and enable you to make purchases with retailers. And they’re much more secure than carrying a wad of cash around town.

When you make a purchase using a debit card, the money is immediately withdrawn (or debited) from your checking account. That means you can never make purchases with a debit card that exceeds the available funds in your account.

The Future of Debit Cards

Traditionally, you’ve needed to have a checking account at an in-person or online-only bank to receive a debit card. But cards like the M1 Spend debit card enable you to work hand-in-hand with your existing investment account in the new realm of digital banking.

Debit Cards like M1 Spend allow you to pay bills, direct deposit a paycheck, then use your remaining checking account funds to funnel into investments if you choose. With a fully integrated banking experience, the checking account no longer stands alone. It becomes part of your overall banking strategy, as does your debit card.

How Does a Credit Card Work?

Unlike a debit card that pulls money directly from your checking account, a credit card is used to charge purchases against a line of credit. And how significant that line of credit depends on how much creditors want to give you based on your credit score.

After you make a purchase using a credit card, you’ll have a grace period before you actually need to pay for the item you bought. At the end of the month (or whenever your billing date is), creditors add up all transactions and assess a minimum payment that’s often a fraction of the total balance due.

Failure to pay a credit card in full each month means you’ll need to pay interest on any unpaid balance. And with startlingly high-interest rates, you could end up paying a lot more than you bargained for each month.

Are Debit Cards Better Than Credit Cards?

Both debit and credit cards can work together to create a solid financial management plan. But there are pros and cons to consider with each.

Pros of Credit Cards

• You’re building credit. When you’re approved for a credit card, that line of credit is now tracked on your credit report. It also means your ability or failure to pay directly impacts your credit score. Debit cards and checking accounts are not typically reported to credit bureaus. So using a debit card for every purchase means you’re not building credit.
• You can reap the rewards. Some credit cards offer rewards points or a percentage of cash back on purchases that meet specific criteria. You can optimize reward points, but be careful. Sometimes the desire to earn rewards can overpower responsible spending habits.
• You’ll have funds in an emergency situation. Unless you’re bumping up against your credit limit, you can use a credit card to charge a purchase in an emergency situation, like a necessary car repair or medical bill. If you don’t have funds available in a checking account, you wouldn’t be able to pay with a debit card.

Cons of Credit Cards

• Credit cards may promote overspending. When you make purchases on credit, you often don’t worry about how high your balance creeps unless you hit the limit. But often, credit card companies offer limits that are much higher than what you can afford.
• Extremely high interest if you don’t pay the balance due timely. If you carry a balance month over month, you could end up paying hundreds of dollars each year to a credit card company for using their money. You can avoid these interest payments by paying your card every month on time and in full.

Pros of Debit Cards

• You can receive a debit card when you open a checking account. There is no extra approval process. So those who are eligible for a checking account are eligible for a debit card.
• With certain cards, you can earn cash back on purchases. Cards like M1 Spend enable you to earn 1% cash back on purchases (when you upgrade to an M1 Plus account).
• You won’t need to pay interest. Since the money comes out of your account in real-time, you never need to worry about paying interest on what you spend.
• You’ll be accountable for your spending. With a credit card, you can spend up to a limit that can be thousands of dollars more than you can afford to pay back. With a debit card, you’re limited to the amount you have. And that means you’re far less likely to spend extraneous funds.

Cons of Debit Cards

• You need to pay right when you purchase. Paying with a debit card is a lot like using cash. When you use your card to make a purchase, the vendor sends a message to the bank to debit your account for the funds. That means that money is no longer available in real-time. You’ll need to stay on top of every transaction coming out of the account to ensure the account isn’t heading for negative territory.
• Entering a pin can be a minor inconvenience. With credit cards, you swipe and go. But for added security, debit card purchases require a pin number, too. This can add some time when making purchases but helps keep your money safe.

How To Choose The Right Debit Card For You

Traditional debit cards are a way to make purchases, remove money from ATMs, and don’t offer much in the realm of account extras. But a card like M1 Spend offers perks beyond a traditional checking account. For current M1 Finance users, M1 Spend offers the ability to manage your investments and borrowing alongside your new checking account.

When you’re shopping around for debit cards, consider elements like:

• Daily ATM & Spending Limits: If you’re planning to use your card frequently, then daily spending limits are something to consider. With the M1 Spend card, the daily spending limit is $3,000, while the maximum ATM withdrawal per day is $510. It’s wise to plan around these limits if you intend to spend more for a big purchase or trip.
• Ability to Earn Interest: Like some credit cards, debit cards may also offer an opportunity to earn interest. When you upgrade to an M1 Plus account (for a $125 annual fee), you instantly start to earn 1% APY* on the balance of your checking account, which is more than most savings accounts are offering. That means if you keep a hefty cash cushion in your checking account, you could earn a decent amount off the interest.
• ATM Reimbursements: If you choose an online-only bank or an institution that’s not close to where you live, you may need to regularly use out-of-network ATMs to get cash. Make sure the debit card you choose will reimburse your fees for ATM use. The M1 Spend card does so for 1 ATM charge per month (or 4 if you upgrade to M1 Plus).
• Ability to Manage Other Financial Transactions: Financial management is confusing enough without using a different bank for every type of account. Look for a bank you trust that enables you to seamlessly manage lending, investments, and transfers between accounts.

The Bottom Line

If convenient spending is your thing, and are able pay the balance in full every month, then a credit card may be the perfect tool to help you boost your financial plan. And, with monthly rewards and cashback, credit has cemented itself as a viable tool for any Money Mind!

However, If you’re someone who may benefit from an added level of spending accountability, it might be time to get a debit card. Before you choose a bank and debit card, remember to look for:

• A bank that offers debit card perks. Look for cards that allow you to earn 1% APY on your checking account, like the M1 Plus Spend card. Other great perks include cash back on purchases, where you can also earn 1% with the M1 Plus debit card. These perks plus the interest you’ll avoid by using debit can help you earn some serious cash.
• The big picture of financial management. Find an institution that’s ready to grow with you beyond your checking account. Companies like M1 Finance are ready to integrate all your banking needs into one highly versatile platform.

Making a smart choice about debit and credit cards means you’re likely to make better financial decisions in the future. So be sure the one you choose is with a company that wants to see you succeed in all aspects of your financial life.

*No minimum balance to open account. No minimum balance to obtain APY (annual percentage yield). APY valid from account opening. Fees may reduce earnings. Rates may vary.

Keep Reading:

• How Much Do You Really Need In Your Checking Account? Here’s How To Find Out
• How to Write A Check (and Why You Should Keep Your Checkbook Around)
• What Your Credit Score Means & How You Can Improve It Starting Today!