Overview:

Cash, Check, Debit Card, Credit Card. What should I use to make purchases?

Purpose:

This purpose of this article is to define and give the pros/cons of using cash, checks, debit cards or credit cards for payments for goods or services. For ease for this article, we are assuming we are only in the United States, but each payment type also has a different pro/con list in different countries. There are also additional forms of payment such as travelers’ checks, Bitcoin, wires, ACH, etc. We’ll discuss all in future Finance First articles.

Cash – This is the simplest to understand. This is a piece of paper or a coin which represents a dollar value as denominated on face of each piece of paper or coin.  

Check – This is a piece of paper tied to your bank account. When you pay for a good or service with a check, the merchant reaches out to your bank associated with the check and withdraws funds from that bank account once the merchant cashes that check.

Debit Card – This is a card tied to your bank account. When you pay for a good or service with a debit card, the merchant reaches out to your bank associated with the debit card and withdraws funds from that bank account immediately.

Automatic Teller Machine (“ATM”) Card – This is a card tied to your bank account. You can not pay for services with this card, but you can go to an ATM machine and withdraw paper cash. The ATM machine will reach out to your bank and withdraw funds from your bank account immediately. Many times, a debit card and ATM card are combined into one card. {Editor’s Note: For this article, anytime we say debit card, it will have the features of both a debit and ATM card}.

Credit Card – This is a card tied to a line of credit you own.  When you pay for a good or service with a credit card, the merchant reaches out to the credit card company associated with the credit card and the credit card company will pay the amount due to the merchant. The credit card company will then bill you approximately 21 days after your monthly cycle ends. Any amounts not repaid at that date would be subjected to an interest charge.

Analysis # 1:  Cash

Pros:

• Cash is just about accepted for any good or service in person
• Some in person goods or services (like a city bus) will only accept cash
• Very liquid, able to hold in multiple spots (wallet, under mattress, bank, coins in car, etc.) and without holding fees
• Amount is always equal to what you pay (no hidden fees)

Cons:

• Very hard to use for an online purchase
• At larger qualities, can be very hard to store
• No protection if stolen
• Loses value against inflation
• Manual process to track spending

Analysis # 2: Check

Pros:

• Only need 1 check vs. holding multiple bills or coins to pay for a good
• Ability to safely assign payment over to another party
• Ability to track spending (though also can be somewhat manual in nature)
• Ability to float cash between the time your use a check to pay for a good and the time the check is cashed by the merchant

Cons:

• Some in person goods or services (like a city bus) will not accept checks
• Very hard to use for online purchases
• Some banks only give you limited details for used checks, which will make tracking more difficult
• Very manual reconciliation process due to timing of checks clearing
• In recent years, many places have gone away from accepting checks, especially at larger dollar values
• If a check is greater than current balance in your account, transaction will be denied, and you will be charged fees for the overdraft. This is also a pro compared to a credit card, where overspending is a significant problem

Analysis # 3: Debit Card

Pros:

• Ability to use for online purchases
• Only need 1 debit card vs. holding multiple bills or coins to pay for a good
• Ability to use at an ATM to quickly get cash without any penalty if you use your own bank’s ATM
• Ability to track spending and easily integrate with other budgeting applications (i.e. Mint)
• Some banks waive bank account fees if you use your debit card for a certain number of transactions

Cons:

• Some in person goods or services (like a city bus) will not accept debit cards
• Some places charge additional fees for using a debit card for a transaction
• If stolen, your cash is gone. While recovery can happen, that cash is still gone from your account for a time being
• If a debit card purchase is greater than current balance, transaction will be denied, and you will be charged fees for the overdraft. This is also a pro compared to a credit card, where overspending is a significant problem

Analysis # 4: Credit Cards

Pros:

• Ability to use for online purchases
• Only need 1 credit card vs. tons of cash
• Many credit cards offer rewards for spending on credit cards
• Ability to track spending and easily integrate with other budgeting applications (i.e. Mint)
• Ability to float cash between spending and payment; at times can be close to 51 days
• Ability to easily set up and make recurring payments

Cons:

• Some in person goods or services (like a city bus) will not accept credit cards
• Significant interest rates for past due balances
• Significant ability to overspending above your means
• If you need cash, can be very expensive fees charged for withdrawing cash from an ATM using a credit card (called a cash advance)
• Some places charge additional fees for using a credit card for transition
• Recurring payments might be set up for services no longer needed or used

What many people don’t realize, is that basically a credit card is just a line of credit. You only owe money for what you borrow (though some credit cards do charge an annual fee). The line of credit has a certain maximum that you can borrow up to. The line of credit has an interest rate that you will pay on the current balance. The major difference is with a credit card is on a credit card the interest is not due until you have a full cycle (normally a month). Said differently, if on a line of credit, I borrow $100,000 on May 1^st and pay it back May 5^th, I would owe interest for May 1^st – 5^th. On a credit card, I could borrow (spend) on May 1^st and the payment for that spend would not be due till the payment due date (which could be as late as June 20^th). If I pay in full on June 20^th, there would be no interest due on the spend.

There is a wonderful Frontline episode on the credit card industry and its history: https://www.pbs.org/wgbh/frontline/film/showscredit/

Conclusion:

As you can see, each payment method has different pros and cons and the suggested use depends on your personal preference, your financial well being and what purchase you are making (i.e. online, city bus, recurring, etc.)

Action Plans:                 

This article was just an introduction to the four most common payment methods in the United States. To figure out which payment method makes sense for you (or to learn of other payment methods), here are some actions steps you should take around payment methods:

• Review other articles on payment types from Finance First, including international payments;
• Review credit card rewards programs to see if any might work for you to take advantage of; and
• Check your spending by payment methods, including the amount, frequently, type and see if you have any trends or ways you can possibly improvement your cash flows, credit score, inflation risks, etc.