Debit or credit: Weighing the financial risks

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Recently Europe and Canada moved toward PIN-only systems for their debit card transactions. The general feeling is fraud will be significantly reduced due to the way transactions are processed there. They are also embedding computer chips in their cards for further security.

For Americans whose debit cards carry either a Visa or MasterCard imprint, transacting abroad should not be a problem. According to Visa, the terminals can accommodate these US-issued cards. But holders of non-Visa or MasterCard-branded debit cards are advised to call their banks before leaving home. There is a good chance their cards will not work abroad.

Visa also suggests all cardholders notify their banks whenever traveling abroad. Many banks use fraud-prevention software that automatically freezes accounts when debt transactions made from foreign countries are detected.

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While Robert Pagliarini CFP, an executive vice president with Allied Consulting Group, a financial advisory firm in Los Angeles, heartily endorses the fiscal restraint required by debit cards, he acknowledges they have their disadvantages: “Some debit card issuers only allow a fixed number of uses each month. After that, they charge fees. Many enforce maximum daily spending limits, creating a problem while shopping [for large ticket items or during the holidays]. Then there are the ATM fees,” says Pagliarini.

But his biggest concern is for younger clients favoring debit rather than credit cards. He thinks they are missing an opportunity to establish their creditworthiness. “With credit cards they can build their credit scores,” says Pagliarini. “That is something they should be doing — creating a track record of responsibly managing credit. It helps reduce the rates they will pay later when they apply for car loans and mortgages.”

Additionally, he explains, no-fee credit cards when used with discipline are basically free, thirty-day loans. They allow users to hold onto money longer while earning interest on balances before paying bills. “Also,” observes, Pagliarini, “Many cards carry extras, like rewards programs and extended warranties on purchases, along with car rental insurance coverage, which most debit cardholders forgo.”

Bottom line: When used responsibly, credit cards offer the better financial deal and are not as "risky" if they are misused. Debit cards, on the other hand, force their users to spend responsibly, but are too frequently embraced without thought to their underlying costs or risks.

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