The dark secrets of debit

Why do banks push debit cards for every purchase you make? Because they stand to make millions—largely at your expense

Last reviewed: July 2009

Quietly but surely, a revolution is under way in how we pay for everything from a cup of coffee to our monthly electric bill. Continuing a climb that started a decade ago, debit cards are now preferred over credit cards by American consumers who use plastic for their in-store purchases.

Spending on these cards, which directly tap your checking account, accounted for about 58 percent of purchases made with plastic in 2008, and are expected to grow to nearly 60 percent in 2009, according to The Nilson Report, a trade publication that covers the payment industry.

The convenience of not having to carry cash and a desire to avoid credit-card finance charges are among the many reasons consumers cite when asked in surveys why they prefer using debit cards. But banks are also accelerating this trend by aggressively promoting perks such as air mileage and other reward programs to entice cardholders to use debit cards more often. Debit cards are especially popular among women and among people between the ages of 18 and 25, who card issuers label Generation P, for plastic, according to a Federal Reserve study.

Of course, card issuers have their own motives for encouraging you to reach for your debit card more often, some of which can hit you in your wallet. If you pay off your balance in full each month, a no-fee credit card is a better choice than a debit card because it allows you to keep your cash in an interest-bearing account until the card bill is due. Plus, credit cards provide more leverage if you get into a dispute with a merchant over something you've bought.

But if you're among the growing legion of debit-card fans, here's what you need to know to help you determine when it makes sense to use them and how to avoid the potential pitfalls when you do.

Tug of war over payments

There are two basic ways to pay with a debit card. When you authorize a transaction by entering your personal identification number, or PIN, your bank account is debited immediately. If you opt instead to authorize payment by signing a sales slip, as you would for a credit card, the payment is processed through a credit-card network and the actual withdrawal from your account occurs later—usually within a couple of days.

Racking up overdraft fees

Since research shows that consumers who use debit cards more often are also more likely to overdraw their checking accounts, card-issuing banks can reap an additional $1 million from nonsufficient-fund fees, according to a report by Mercator Advisory Group, a Waltham, Mass. company that does research for the payment industry.

Unequal fraud protection

In practice, Visa and MasterCard both have "zero liability" policies that go beyond the federal law by exempting debit cardholders from liability in most cases when a bank investigation confirms a transaction is fraudulent. But there are loopholes in those policies.

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