Debit cards have become a very popular way to pay for everything from fast food to rental cars. The Federal Reserve reports that debit card transactions have been growing more than 20 percent annually and have surpassed credit card transactions.
The appeal is understandable. Debit cards are quick and easy to use.
But using a debit card can cost you hundreds and even thousands of dollars. We'll show you why you should never carry a debit card.
More Risky than Carrying Cash
In its 2007 Debit Issuer Study, PULSE EFT Association reported that U.S. financial institutions lost an estimated $662 million to debit card fraud in 2005. There is no end in sight.
You'd be safer carrying cash. Although you don't have much recourse if it's lost or stolen, but at least your loss is limited to the amount of the missing currency.
Carry a debit card, and you put the entire balance in your bank account at risk. If you link your checking account to your savings account to avoid overdrafts, you put the balance in both accounts at risk.
If a thief gets your credit card, the federal Truth in Lending Act limits your liability for any fraudulent credit card charges to $50. You may not have to pay even that amount, as many financial institutions don't impose any charge on their defrauded customers. And while the theft is being investigated, you can refuse to pay any part of the unauthorized charges.
Debit cards fall under a completely different law, the Electronic Fund Transfer Act. To limit your liability to $50, you have to notify your bank within two business days of discovering that you're debit card has been lost or stolen. Wait longer than that, but give your bank notice of the fraudulent transactions within 60 days of when your statement is mailed, and your maximum liability jumps to $500. Miss that deadline and you could lose all the money in your account.
Because the debit card accesses fund directly out of your account, you can be left without your grocery money while the fraud claim is being investigated.
The $350 Taco
One trip to Taco Bell was enough to send Joseph Rizk's checking account into freefall.
Rizk made the mistake of paying for fast food with his debit card. He figures he spent only about $5 more than he had in his account. Unfortunately, by the time he realized there was a problem, the bank had hit him about $350 in overdraft fees. At $25 to $35 per occurrence, it's easy to rack up hundreds of dollars in needless NSF fees.
"I overdrew, and they pretty much pummeled me with charges," said Rizk.
The Center for Responsible Lending, a consumer group, estimates that overdraft charges cost people about $17.5 billion each year. The center's research reveals that about 45 percent of those overdrafts are the result of using a debit card or taking out cash from the ATM.
Banks used to refuse any debit card transaction that would overdraw a depositor's account. But not any more. Banks could warn depositors when their accounts are close to being overdrawn. But they don't.
Instead most financial institutions automatically enroll their depositors in a program that loans them the amount of the overdraft—but at a steep price. The Center for Responsible Lending estimates that Banks that offer these lending programs can expect a sharp increase in overdraft revenues, as much as 200 to 400 percent.
Calculated as an interest rate, rather than a fee, the cost of these loans is astronomical. The average amount of a point-of-sale purchase that overdraws an account is $14.75. The average fee is more than double that amount. According to the agency, most consumers only use these loans for a few days. So on an overdraft loan, the annual percentage rate can be as high as 20,000 percent.
In defense of this practice, bankers like to point out that it's the responsibility of the account holders to monitor their account balances and avoid overdrafts.
Of course, that requires the account holder to know how much money is in their account.
How Can You Know Your Account Balance?
R. C. Welborn, learned the hard way about the risks of using debit cards.
To make sure he didn't overdraw his account, he checked his online bank statement. Since it showed $80 in his checking account, he fell free to make several small purchases a few days before his paycheck was deposited. Using his debit card, he bought two gasoline fill-ups, snacks and cigarettes, totaling about $65.
Although the balance in his account was more than enough to cover the price of what he bought, when he checked his account about ten days later, he found he had incurred $120 in overdraft fees.
"I couldn't figure out what was going on, I knew I had money in the bank," Welborn remembered.
Like most people, Welborn didn't know that merchants can place a pre-authorization hold on a customer's account. In situations where the exact amount of the transaction isn't settled when the approval is given, it makes sense a merchant would want reserve a little more to cover their transaction. If you give your debit card to a waiter, hotel clerk, car rental company, or gas station, the merchant is likely to get an approval of a higher amount—to cover any tip on their service, higher purchase amount, or room service. Car rental companies that accept debit cards routinely place holds in the amount of $300 to $500.
Now Welborn understands that the pre-authorization hold the gas station put on his account resulted in overdrafts on at least six other small transactions. He estimates that he paid over $2,000 in overdraft fees because he used a debit card.
"The quickest way to bankrupt yourself is not knowing what's going on with your debit card, but if you don't get a warning when you're doing it, how to you know?" Welborn asked. "I won't touch a debit card anymore. I do everything with cash."
Pre-authorization holds placed by merchants are just one of the factors that make it difficult, if not impossible for a depositor to know his or her available account balance. It's becoming more difficult to tell when a transaction hits an account.
Some debit cards allow for both signature-based debit card transactions, that, like a check, take a few days to clear, and PIN-based transactions, which hit the depositor's account instantly. Take into account paper checks that merchants and service providers frequently convert into electronic drafts, and, without real-time account information, it's impossible to know what's in any checking account.
Nessa Feddis, senior federal counsel for the American Bankers Association in Washington explains that even the banks don't have up-to-the-minute information. "We don't have real-time transactions. There will always be outstanding transactions that the consumer has authorized but have not hit the bank."
Comparing debit card transactions to a plastic checks, some financial institutions instruct depositors to keep track of their purchases, just like in the old days when checks and drafts were the only way to draw funds from a checking account.
But in the old days, a depositor could wait for their bank statement to reconcile their balance. Now, by the time the statement arrives, the damage may already be done.
"The debit card is really where it's a serious problem," argues Ed Mierzwinski, the consumer program director of the U.S. Public Interest Research Group in Washington. "It's harder to keep track of your balance because of the tricks banks use."
In addition, there are no regulations or statutes that limit the amount of a pre-authorization hold, or the length of time that it can be imposed on an account.
When Penny Chaisson's bought $20 worth of gas, the station put a hold of $75 on her account, more than 3 times the amount of her purchase. She contacted both the gas station and her bank, but each pointed a finger at the other. Even after escalating her complaint to management, it was 72 hours before the hold was released.
These holds stay in place until the bank or the requesting merchant gets around to releasing the amount held in excess of the purchase amount. Generally this takes a few days, but it could be longer.
How You Can Protect Yourself
Promptly reconciling your account to the monthly statement or monitoring your account balance on-line won't always prevent loses associated with the use of a debit card.
There is only one solution—Don't carry a debit card. When opening a checking account, it is standard practice for a bank to send the depositor a combination debit/ATM card. However you can pick and choose the services you want to accept. If you want to avoid the risks of having a debit card, but would like the convenience of ATM access, you bank will issue you a card for just that purpose, without the debit card function.
You can always pay for your purchases with cash or a credit card, since both are safer than using a debit card.