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What You Need to Know About Debit Cards

By Mary Hunt

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Many people believe — falsely — that they can't get into financial trouble if they use a debit card rather than a credit card ("The money is coming straight out of my checking account!"). But debit cards carry risks of their own that you need to understand to be a savvy consumer.

HOW DEBIT CARDS WORK

You can use a debit card for two types of transactions:

A debit transaction that requires you to input a PIN (personal identification number) — this type is known as an "online" debit;
A "credit" transaction that requires your signature — also called an "offline" or "signature" debit.

With a PIN-based debit-card transaction, funds for the purchase are withdrawn from your checking account immediately, i.e. at the time of the transaction. With a signature transaction, funds remain in your checking account until the transaction posts to your account one to three days later. (Even though the store clerk may say that your debit card will be run as "credit," a signature-based transaction isn't a "credit" transaction at all. It's simply a slightly delayed debit.)

LIMITED CONSUMER PROTECTION

Debit cards are regulated by a rather weak law called the Electronics Fund Transfer Act. The law states that if your debit card (or number) is stolen and funds are removed from your account, your loss is limited to $50 if you report the matter to your bank within two days. (How many people balance their checking accounts every two days?)

If you fail to report a discrepancy in your account within the two-day time frame, you're liable for up to $500 in charges made by a thief. And if you don't report the matter within 60 days, you may be liable for the entire amount.

The law has another provision that protects banks more than cardholders: if your bank determines the thievery occurred because you were negligent with the card or handled it in a way that gave access to a thief, the bank can choose not to cover any losses.

A CAUTIONARY TALE

Don't assume that you'll never have a problem with your debit card getting into the wrong hands (remember, only the card number is needed to buy something online — no PIN or signature is required).

Consider this story from Carol, one of the members of my Debt-Proof Living website:

On the day after Thanksgiving, a stranger went shopping online with Carol's debit-card number (she still doesn't know how he got it). The thief bought thousands of dollars worth of Christmas gifts via Target's online store using Carol's number.

More than a week passed before she found out what had happened (many days beyond the two-day deadline). When the bank told Carol she was overdrawn, she was horrified. Not only did the thief clean out her checking account, but when it became overdrawn, the bank automatically tapped into her savings. Only when everything was gone did they contact her.

The bank, of course, had no way of knowing if Carol had authorized the charges (despite her protests, they may have even suspected she made the charges herself). Eventually, however, the bank agreed to investigate. Carol, meanwhile, went through the holidays broke. After several months(!), the bank agreed to restore some of the money that was stolen, but not all of it.

OTHER LOSS SCENARIOS

Let's say you buy something with your debit card via the Internet. The item never shows up or it shows up broken — or maybe it's not the correct item or you have a problem getting a refund. Since you paid with a debit card, you're on your own because the money has already been withdrawn from your account.

No credit is involved, so you have none of the protection afforded you by the federal laws that regulate credit cards.

Or let's say you're going on a cruise and you pay for it on your debit card. The cruise company files bankruptcy weeks before you're to sail. Can you get your money back? Not a chance. But if you had paid with a credit card, no problem. The issuing bank has to eat the loss — not you. It's the law.

TAKE YOUR BANK ACCOUNT WITH YOU?

Don't fall for the idea that you are being "more responsible" if you use a debit card for your daily spending rather than a credit card. The fact is that people tend to spend more if they can simply swipe a card (whether debit or credit) rather than paying with cash.

Yes, the money may be coming directly from your checking account (rather than adding to a balance on a credit card statement), but when you shop with a debit card, in effect you're taking the entire contents of your bank account with you! That's quite a temptation.

CASH RULES!

A better option for day-to-day spending is to simply use cash. To be sure, cash is more inconvenient than using a debit card, but that's a good thing. With cash, you have to plan ahead — you have to get the cash before you go to the store. Pulling $20 bills from your wallet requires you to engage your brain and forces you to consider how much you are actually spending. That is how it should be!