Consumer Reports warns shoppers could lose money when using debit instead of no-fee credit cards

Posted Tuesday, September 18, 2007

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Debit cards are rapidly becoming the dominant form of payment for consumers with spending topping $1 trillion for the first time in 2006—but many consumers might not realize they are standing to lose money when using debit.

Although debit card users appreciate the convenience of not having to carry cash or avoiding credit card financing charges, the September issue of Consumer Reports Money Adviser uncovers the darker side of debit: Banks push the use of debit cards on every purchase because they stand to make millions—largely at consumers expense, from charging consumers for certain types of transactions and racking up overdraft fees.

If you pay your balance off in full each month, Consumer Reports Money Adviser recommends using a no-fee credit card rather than a debit card, as it allows you to keep your cash in an interest-bearing account until the card bill is due. In addition, the cash-back, mileage and other rewards that accompany credit cards tend to be much more generous than debit card perks. However, for those consumers who are among the growing legion of debit card fans, the September issue of CRMA offers the following information to help consumers determine when it makes sense to use them and how to avoid potential pitfalls when they do.
 

There are two basic ways to pay with a debit card. When you authorize a transaction by entering your PIN number, 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 an actual credit-card network and the actual withdrawal from your account occurs later, usually within a couple of days. Retailers prefer that you use PIN transactions while banks encourage consumers to sign for purchases by offering mileage points or other incentives. And some banks charge you a fee ranging from 25 cents to $1 for each in-store PIN-based transaction as further incentive to make consumers sign for their purchases because signature transactions are more profitable for banks.

The interchange fees that banks get from merchants for processing signature payments is much higher than that 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 $1.48 if the customer signs to authorize the purchase. Those higher interchange fees are a substantial source of revenue for banks. If a card issuer with 350,000 customers persuades them to increase their signature-debit transactions from five per month to nine, it could increase its interchange income by nearly $5 million a year.
 

Research shows that consumers who use debit cards more often are also more likely to overdraw their checking accounts. Therefore, card-issuing banks can reap an additional $1 million from non-sufficient fund fees. According to CRMA, customers who used debit cards more than 20 times a year paid an average of $223 in non-sufficient fund fees annually, compared with $40 for those who didn’t use debit cards at all.

Until 2003, banks routinely declined debit-card purchases and ATM transactions for amounts that exceeded a customer’s balance unless they 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—which allow banks to pay overdrafts without alerting customers that they are exceeding their balance—has increased to 80 percent. Customers don’t realize that they will be charged fees, which average more than $30, if they proceed with the transaction.

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. The amount that’s blocked can significantly exceed the actual amount of your purchase.
 

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 within two business days of discovering the problem. And if you fail to report the unauthorized charges within 60 days of the statement that lists them, you could be held liable for any unauthorized withdrawals after that date.

Also in the September issue of the Consumer Reports Money Adviser are articles on: How to recession-proof your finances, when to collect Social Security benefits, tax advice for multi-state residents, the truth about Direct-Buy, and how excessive fees can eat away at your 401K portfolio.