Debit cards are similar to credit cards in that they do not require the use of cash or paper checks for purchases. However, the primary difference between debit and credit cards is that debit card purchases withdraw money from a linked checking account. A credit card enables purchases to be paid for over time in monthly payments, in accordance with a predetermined credit limit. Debit cards have become increasingly popular around the world since the late 1990s. While these pieces of banking plastic are convenient, there are also some significant drawbacks.
One of the best advantages of a traditional credit card is consumer protection against unauthorized purchases. However, a debit card does not have the same protection, creating a significant drawback. Because debit card transactions pull money out of a bank account, it costs financial institutions money if charges are disputed. This makes banks less willing to properly investigate fraud claims. Even banks who are more open to exploring the idea of unauthorized debit card charges tend to set a limit to how much they will pay of a fraudulent transaction. In some cases, the cardholder is held liable for the first $50 or more of unauthorized charges.
Debit cards are ideal for people who want the convenience of buying items online and not carrying cash or checks without incurring new unsecured debt. A significant problem with the credit card industry is it can encourage people to buy items they cannot afford. Because the debit cardholder must have sufficient funds to make a purchase, this prevents the financial burden of new debt.
Paying for gas purchases at the pump is a modern credit card convenience, but does not work the same way for debit cards. Because of the risk of the gas station not being fully paid for a consumer filling his or her fuel tank, merchants often hold $50 to $100 on a debit card. To avoid frozen funds, which could takes days to fully be released, it is best to go inside and have the cashier ring up an exact transaction amount on a debit card.
Debit cards offer a lot of convenience. Carrying large amounts of cash is unsafe, and mailing checks for bills is time-consuming. Thanks to debit cards, consumers can pay utility bills over the telephone or online, and use their cards just like cash for purchases such as food, clothing and even daycare expenses.
Using a debit card for a hotel is usually not a good idea. Most hotels hold money over the actual purchase amount in case a room is damaged or incidental expenses are incurred such as room service and telephone calls. This could create bounced checks and other financial inconveniences. It is best to pay cash for a hotel room or use a credit card.
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
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.
Retailers generally prefer that you use PIN transactions, while banks encourage you to sign for purchases by offering mileage points or other incentives for signature-based debit payments. That's because signature transactions are more profitable for banks. The interchange fees that banks get from merchants for processing signature payments is much higher than for PIN-based transactions. On a $100 purchase, for example, the bank that issued the card typically collects only about 20 cents in interchange fees when payment is made using a PIN. But it gets at least seven times more than that if the customer signs to authorize the purchase, says Avivah Litan, a senior analyst at Gartner, an information technology research company in Stamford, Conn.
Those higher interchange fees—which merchants ultimately pass on to consumers in the form of higher prices—are a substantial source of new revenue for banks.
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.
Until 2003, banks routinely declined debit-card purchases and ATM transactions for amounts that exceeded a customer's balance unless he or she had decided to link the account to a line of credit, credit card, or savings account to cover overdrafts. But since then, the number of banks using overdraft software packages has increased 80 percent. The software allows banks to pay overdrafts without alerting customers that they are exceeding their balance, according to the Center for Responsible Lending, a consumer advocacy group. Customers don't realize that they'll be charged a fee, which average nearly $30, if they proceed with the transaction. This fee is essentially a finance charge for a short-term overdraft loan, which the bank swiftly recoups from the account holder's next deposit.
"You may use a debit card to avoid paying high interest on credit-card balances, but when you're hit with what amounts to high-cost overdraft loans, your debit card can quickly become the most expensive credit card on the market," says Eric Halperin, director of the Washington, D.C., office of the Center for Responsible Lending. The group estimates that consumers pay $17.5 billion in overdraft loan fees annually—nearly half of which are triggered by debit-card transactions or ATM withdrawals.
Consumers not only overdraw their accounts when they fail to keep track of all of the lattes or newspapers they've bought with debit cards, but a practice called "blocking" can also increase the odds that overdrafts will occur. Some hotels, gas stations, and other retailers put a hold on funds in your checking account until a debit transaction is processed—which can take from one to several days for signature-based payments. What's more, the amount that's blocked can significantly exceed the actual amount of your purchase.
"When you swipe your debit card for $25 worth of gasoline, $100 of your account balance may be temporarily blocked because the system doesn't know if you're filling up a Miata or an Explorer until the transaction has settled," says Greg McBride, a senior financial analyst at Bankrate.com. "If you're running a low account balance, blocking can lead to multiple overdrafts, which is why debit cards may be fine for buying a cup of coffee but not so good to use for rental cars or hotel bills, where blocking can tie up hundreds of dollars."
To avoid being hit with costly bounce-protection fees, McBride recommends that you record all debit transactions in your check register and regularly monitor your account balance online. He also advises that you sign up for overdraft protection linked to a savings account.
Unequal fraud protection
Under federal law, your liability for fraudulent charges on a debit card can be greater than it is for a credit card. With a credit card, you're only responsible for up to $50 in unauthorized purchases. But with a debit card, you can lose up to $500 if you don't report the theft or loss of your card or PIN within two business days of discovering the problem. And if you fail to report the unauthorized charges within 60 days of the date of the statement that lists them, you could be held liable for any unauthorized withdrawals after that date. Those include the full value of credit lines and funds in savings linked to your checking account for overdraft 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.
Even if consumers were granted liability protection that is identical to that for credit cards, the headaches of setting the record straight are much greater with fraud on a debit card, says Ed Mierzwinski, consumer program director at the U.S. Public Interest Research Group. "Unlike a credit card, payment for a fraudulent transaction has already come out of your bank account, so you're fighting over your money, not theirs, and you could be bouncing other checks while you're waiting for it to be resolved," he says.
What's more, while there have been a few well-publicized security breaches involving the theft of debit-card PIN numbers by hackers breaking into store computer databases, retailers generally report that the incidence of fraud is higher when consumers sign for debit purchases rather than using a PIN. "Signature-based transactions are definitely less secure, so it's really outrageous that banks are steering customers to use signatures rather than PINs simply because it generates more fee income," says Avivah Litan. One major retailer confided to her that fraud on signature-based debit purchases at his company's stores is 15 times higher than for transactions authorized by a PIN.
Ironically, although your odds of becoming a fraud victim are lower when you use a PIN, your protection from liability if fraud does occur is greater with a signature debit card because card issuers may exclude some types of PIN transactions from their zero-liability policies. Litan advises calling your card issuer to find out what your liability is for unauthorized signature vs. PIN debit purchases. She says that since banks encourage the use of signature debit, you're likely to have better protection when you sign.
Credit Card Perks
Buy with American Express, MasterCard, Visa, or a growing number of debit cards and you're entitled to benefits that you might not even know about. To determine what perks you have and how they work, read the material that came with your card. (If you've lost it or didn't get a full explanation of benefits, ask for a copy or check the issuer's Web site.) Note the fine-print exceptions, including dollar limits on coverage. To qualify, you generally must use the card for the entire purchase. To take advantage of a benefit, you file a claim, which might involve sending your receipt or the item itself. Common benefits from Amex, MasterCard, and Visa are below. (A Discover card spokesman said some benefits are available with some cards, but he could not elaborate.) Benefits differ, so check with your card issuer.
Cards often double manufacturer warranties up to one extra year on purchases up to $10,000. The product must come with an initial warranty for no more than three to five years, depending on the card. That's one reason not to buy an extended warranty for most products.
Purchase or product protection
Cards might cover you if an item is stolen, accidentally damaged, vandalized, or lost. For damage, the card issuer will arrange for repair or, in some cases, replacement or refund. American Express covers an item for up to 90 days, with a limit of $1,000 or $10,000 per occurrence, depending on the card, and $50,000 per policy year. Plans don't cover shipping and handling expenses. Coverage may apply only as backup to your own insurance.
If you find the same product at a lower price within 60 days of purchase, some cards will reimburse you for the difference. Online purchases might be excluded.
This provides a refund if you're unhappy with an item but the retailer won't take a return. The American Express program applies to purchases up to $300, $50 more than MasterCard and Visa. All have a $1,000 annual limit.
No matter which kind of economic recovery we get, diversification still wins
Most experts agree that the recession is now over: In the most recent reports by the 12 regional Federal Reserve districts, all but one noted economic improvement. But what lies ahead for investors? The answer depends on whom you ask. Economists and investment professionals describe their forecasts for the direction of the national economy in ways that sound like carnival rides: the Rebound, the Lightning Bolt, the Double Dip.
Fortunately, as long as your portfolio is diversified, your investments are probably going to be in good shape no matter which ride we take. And you won't need to be incredibly precise in your predictions for growth. Clairvoyance isn't important, but diversification is.
Three recoveries, one plan
Although the economic forecasts for the next 12 to 18 months vary greatly, they can be reduced to three essential types, and each has occurred in recent economic history.
Probably the most common expectation among forecasters is for the economy to experience a recovery, but a tepid one, as occurred in 1992. The thesis is that consumer spending, constrained by tightened credit, falling home prices, and high unemployment, is not going to rebound anytime soon. But productivity will remain high as companies return to normal production levels, though they'll employ fewer workers.
Although this forecast doesn't sound very optimistic—and it certainly isn't for some aspects of the economy, such as employment—historically a slow recovery is better for stocks than a rapid upturn. Liz Ann Sonders, Schwab's chief investment strategist, notes that since the 1970s, the Standard & Poor's 500 stock index rose more than 7 percent per year during periods of lukewarm economic recovery, defined as growth in the gross domestic product of no more than 6 percent annually. Although it's counterintuitive, in periods when the GDP grew at a more rapid clip, stocks have actually fallen 4.6 percent.
That can occur if the economy suddenly snaps back from the deep recession, which is what happened in the mid-1970s, observes Dean Maki, chief economist at Barclays Capital. And there is evidence that the manufacturing sector has started to expand production, just six months after a sharp contraction in response to the credit crisis that began in fall 2008. In addition, the bulk of the $800 billion in government stimulus spending will enter the economy in 2010, which should add wind to the economic sails.
The most pessimistic scenario is that we'll fall back into another recession, as the spurt of economic activity of the summer peters out. The evidence isn't difficult to marshal. Conditions that could weigh down the economy include an unemployment rate of almost 10 percent; residential real-estate prices perhaps bottoming but leaving in their wake foreclosures and empty houses; a huge government deficit; seemingly stingy credit markets; and uncertainty about the U.S. dollar and increased inflation. Those problems could result in another contraction, as occurred in 1982.
Lessons from the past
Nobody expects history to exactly repeat itself. Most likely, this recovery will borrow from two or even all three of those scenarios and will have characteristics of its own for future economists to look back on and ponder. So we attempted to find out whether we could build a portfolio that could survive those three types of recovery.
We turned to historical data to see how certain types of investments played out in those past recoveries. We looked at the inflation-adjusted returns for four major asset classes for two years following the end of past recessions (see chart on facing page). And as it turns out, even in the worst-case scenario, diversified investors would have done well. This hindsight might be obvious now—on balance you would expect stocks to do well after a recession. But considering the trepidation among investors today, it's worth a closer look to help provide some guidance on how to move forward.
The first thing to notice is that contrary to what many people think, long-term Treasury securities are not necessarily the safest place to be. They fared best following the 1991 recession, gaining 27.5 percent. But during the double-dip recession of 1980 to 1982 they lost more than 8 percent in value. As the market historians at Ned Davis Research noted recently, long-term bonds make money when the economy is contracting and investors seek safety, which drives up prices. Since 1957, bonds have lost money on average during times of economic expansion. Somewhat curiously, bonds and stocks have appreciated in price this year. Normally the prices of those two assets move in opposite directions.
Another observation: After each recession, small-company stocks were the clear winner, something we've pointed out here in the past. Part of the explanation lies in the fact that small-cap stocks are usually sold off faster when the economy heads south. And during the latest recession small-caps lost a stomach-churning 60 percent, much more than the 37 percent that small-caps gave back in previous recessions. But as the economy improves, small-caps tend to snap back more quickly as well. In short, there's higher risk in small-cap stocks, but there's also a higher reward.
Large-cap stocks, on the other hand, tend to be the late bloomers, not outperforming until the recovery is well underway. Nonetheless, there's still a place for them in your portfolio before that point arrives: Large-cap stocks pay higher dividends, currently yielding about 2.2 percent, which rivals most certificates of deposit. So there are worse places to put your money right now.
From losses to gains
For diversified investors, even the bad news looks pretty good. Based on the three common portfolios we constructed, no money was lost over the two-year periods, even after adjusting for inflation, which was significant in the 1970s and early 1980s. The pie charts above show how three different asset allocations fared. What stands out again is the value of diversification—large tweaks in asset allocation didn't have much of an impact on total return. So moving forward from this recession, you'll probably be ahead of the game as long as you maintain broad diversification in your portfolio.
Of course, some observers still maintain that it's different this time. And that may be the case. In particular, today's investors have new assets with which to diversify, specifically foreign stocks and commodities. In the past it was impractical to add those to the average individual's portfolio, but today you can easily boost your diversification with exchange-traded funds and foreign mutual funds.
Having a debit card in your wallet is a great tool for making convenient purchases. In this episode I'll discuss the pros and cons of using them and share lots of tips on how to lower their associated risks.
Ok, let's start out with the major advantages of paying with a debit card instead of paying with cash, check or a credit card:
1. Convenience is certainly the number one advantage in my book! You don't have to carry just the right amount of cash, write out a paper check and enter it into a register, or make a credit card payment at a later date.
2. It takes less time to complete a purchase. Debit cards are accepted by merchants with less scrutiny than are checks or credit cards. And swiping a card is much faster than writing out a check.
3. It keeps you within budget. When you use a debit card you're limited to spending the amount of money you have in the associated account. This prevents you from accumulating debt or being charged interest and those annoying late fees from a credit card company.
4. They're easier to get than a credit card. Most bank checking and savings accounts offer you the option to have a debit card linked to your account, without having to complete a lengthy application.
5. You can easily get cash. You can opt for "cash back" at most stores or use your debit card as an ATM card at cash machines.
On the flip side, here are the disadvantages of using a debit card over other payment methods:
1. Disputed charges can be more difficult to resolve. Since money was spent out of your account at the moment of purchase, you have more risk with a debit card than with a credit card if the item is defective, misrepresented, or never gets delivered to you.
2. Some banks may charge you extra fees. There could be monthly service charges, over-limit fees, per transaction costs, or penalties for dropping below a minimum required balance that result from using a debit card.
3. You don't improve your credit score. Building up your credit score is an important consideration for your financial future. Paying bills, such as credit card payments, on time is the most effective way to increase your rating or to maintain a high credit score.
4. You can't take advantage of reward points. One of my favorite reasons for using a credit card when making any large purchase is the opportunity to get travel reward points. There are many different types of cards that offer a variety of great incentives.
5. It gives you lower levels of fraud protection. If a thief gets your Personal Identification Number, they could easily empty your bank account. Fraud certainly happens with credit card use as well. However, most credit card companies put a hold an any account that shows unusual activity.
6. And lastly, your potential liability for misuse is unlimited. This contrasts the low risk that comes from misuse or theft of a credit card.
According to the Fair Credit Billing Act, your maximum liability for unauthorized use of your credit card is just $50. If your card was stolen, and you report the theft before any misuse occurs, your liability is $0! If you have the card in your possession, but someone stole your credit card number, your liability is still $0.
Debit Card Fraud--Report Lost Cards Quickly to Limit Your Liability
Your liability for misuse or theft of a debit card under the Electronic Fund Transfer Act is very different. It completely depends on when you report the loss. When it comes to debit card fraud, please remember that you must act very quickly to give yourself as much protection as possible.
If you report a debit card loss before it's used without your permission, your liability is $0, just like with a credit card. But if you wait to report a stolen card or theft of your debit card number, your financial risk increases as follows:
· Your loss is limited to $50 if you notify your card issuer within two business days after discovering your loss.
· Your loss is limited to $500 if you report it within 60 days after your account statement was mailed to you, but
· Your liability if unlimited if you miss the 60 day deadline! You could lose all the money in the account linked to your debit card plus any overdraft fees and penalties.
Protect Yourself from Debit Card Fraud
So, what can be done to lower the risk of using a debit card? Well, I strongly recommend using debit cards only for smaller purchases from trusted merchants. It's a good idea to never let the card leave your sight during a purchase. Illegal electronic skimmer devices are very small and can easily be hidden and quickly used by thieves to copy your information. When making a big ticket purchase or buying over the phone or Internet, always use a credit card.
Here are some additional tips that can save you lots of potential frustration and grief:
· Sign the back of your cards as soon as you receive them · Don't carry cards with you that you will not need
· If possible, carry cards separately from your wallet
· Never give a card number over the phone unless you really trust the person or company
· Never e-mail a card number to someone or give it in response to an e-mail solicitation · Never sign a blank credit or debit charge slip
· Never loan a card to anyone
· Draw a line through blank spaces above the total on any credit or debit slips to avoid them being altered
· Make your Personal Identification Number something unique that a smart thief couldn't easily figure out
· Never create a Personal Identification Number that match your address, birthday, social security number, phone number, or any other number that could possibly be linked to you
· Never give your Personal Identification Number to anyone and do not keep it with your debit card
· Keep your debit card receipts in a safe place until you can match them against your account statement each month, then destroy them · Check your homeowner or tenant insurance policy to find out if it includes any liability for card fraud
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