Credit, Debit and Charge: Sizing Up the Cards in Your Wallet

While debit cards and charge cards often share wallet space with their credit card cousins, each type of card is separate and distinct. To figure out which one or ones are right for you, read on.

True credit cards have a set spending limit ($500, $2,500, $25,000, etc.) based on the cardholder's credit rating and current income. They enable consumers to carry a balance from month to month, and they charge interest on the outstanding debt. In general, as you spend more money and make regular monthly payments, your credit limit increases. If you chronically make late payments on your monthly bills or miss payments, your limit will be reduced (or your credit cut off), and the interest rate charged on the balance may be increased.

While many credit cards are available with no annual fee, interest rates can run as high as 30%. Shop carefully when selecting a new card. If you have had trouble managing your credit and cannot obtain a credit card via the standard offerings, some credit card companies offer secured cards. With these cards, you deposit money with the card issuer – generally $300 to $500 – and then you can obtain a credit card with a spending limit equal to the money deposited. The deposit earns interest and is generally refundable once you establish a satisfactory credit history.

When you think about charge cards, think American Express. Unlike credit cards, charge cards do not have a monthly spending limit. You can make a virtually unlimited number of purchases with your card, but you need to pay the balance in full each month. To discourage you from carrying a balance, charge cards generally impose a fee and tack on penalties anytime you don't pay in full.

Like credit cards, some charge cards also charge a yearly fee. Despite the fees, for many consumers the cost of having a charge card is often significantly lower than the cost of having a credit card because you avoid the interest-related debt that you can rack up with a credit card.

Debit cards work like plastic checks. When you make a purchase with a debit card, the payment for the purchase is taken directly from your bank account. If your account has insufficient funds to cover the expense, your card payment will be declined. Online, debit cards function like credit cards, requiring you to provide the expiration date and code on the back to the merchant, before a charge is made. But offline, your card functions much like an ATM card does, requiring you to enter a personal identification number (PIN) to initiate the transfer of funds from your bank account to the merchant's bank account. 

If you want to curb your spending and avoid the urge to buy stuff that you can't really afford, debit cards are a good choice. There are no monthly bills, no interest charges and generally no fees to obtain a debit card from your local bank. Visa and MasterCard affiliates issue most debit cards, so most merchants that accept Visa and MasterCard credit cards also accept the debit cards.

However, debit cards may be subject to fraud just as credit cards are. And they have fewer protections against fraud and can make it more difficult to get your money back. One other point: Because they don't involve paying back a credit card, using a debit card doesn't help you build a credit history and good credit rating.

Putting plastic in your wallet is a convenient way to avoid carrying cash to make purchases. And if you participate in the various perks programs offered by credit cards and charge cards, you can earn airline miles or a variety of other rewards and points for purchasing items that you would have bought anyway.

From a financial perspective, debit and charge cards are structured so that they pose little danger to your financial wellbeing. Their internal controls discourage or forbid carrying a balance, so the temptation to make purchases that you can't afford is minimized.

Credit cards, on the other hand, have served as the instrument of financial ruin for more than a few careless shoppers. Interest rates border on the obscene and, as minimum monthly payments can stretch out a purchase's payback period for years, credit cards encourage consumers to live beyond their means. To avoid these pitfalls, pay attention to your spending habits and keep in mind that being able to afford the minimum monthly payment does not mean that you can afford to make the purchase: It simply means that if you buy that item, not only will you be in debt, but the interest payments will increase the total cost of the item to well beyond the sticker price. For more, see Credit vs. Debit Cards: Which is Better?