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Guru Q&A: Will Debit or Credit Better Protect Me from ID Theft?

FiLife User Question: I have been told by a number of people that they use their credit card over their debt card because it offers better protection against identity theft. Is this true?
-Paul

FiLife Guru Response from Dave Hanson: While debit card issuers generally offer more protection than they did in the past, policies vary substantially. Your issuer should have provided you with a written statement explaining their policies. If you do not have this, you should contact your bank to find out exactly what protection you have and what you are liable for in cases fraud.

By contrast, credit card protection tends to be both stronger and more uniform. This is partly because the law requires that credit card users are generally not liable for more than the first $50 taken through fraud. As a practical matter, virtually all card issuers cover that $50 as well.

The basic functionality difference between debit and credit cards also protects credit card users better than debit card users. Credit cards allow us to borrow money from the credit card issuer. By contrast, debit cards enable us to use our own money in our own bank accounts. Thus credit cards put creditor money at risk from fraud, while debit cards put our own money at risk. When creditor money is fraudulently tapped from our credit cards, we will face some hassle: replacing the card, perhaps getting a charge or two denied, perhaps an overlimit fee that needs reversing. But if out own money is so tapped, it can send checks and auto-debits bouncing right and left, causing a situation that can be far more difficult to remedy.

Bottom line: a debit card is significantly more vulnerable to fraud than a credit card. That’s just one reason why using a credit card is preferable–provided that the user has the financial discipline to pay off the balance in full each month.

FiLife Guru Response from Dean Binder: Debit card usage does NOT appear on your credit reports therefore it has no impact on your credit scores. If you shift all your purchases over to a credit card for the fraud protection then keep in mind that the debt reported to the credit bureaus each month by your credit card issuer can have an adverse effect on your scores. So, it’s a good idea to weigh the added protection versus the score damage, especially if you’re in the market for a new loan.

Some people believe you should charge everything you possibly can on a credit card for the rewards points/cashback and the fraud protection. These folks tend to be younger and therefore are more susceptible to more radical score movement, not a good combination.

My advice is to securely store your debit and credit cards and try to minimize the potential for fraud. Use your credit cards responsibly and try to pay them in full each month.

FiLife Guru Response from Dave Hanson: Thanks for weighing in Dean, and a belated welcome to FiLife guru-dom.

Of course you are correct about debit cards not reporting to the credit bureaus, and that “the debt reported to the credit bureaus each month by your credit card issuer can have an adverse effect on your scores.” And as you well know, that adverse affect becomes more likely once the reported balance on your credit card exceeds 10% of the available credit, and especially once it exceeds 50% or (even more so) 90% of that limit.

Happily, there is a simple solution to this problem. Since credit card companies report the balance on the card as of the close of the billing cycle, we can simply pay off most or all of that balance before the cycle closes.

So for example. Suppose my cycle closes on the Friday the 10th on the month. If I have a balance of $500 on my credit card as of Wednesday the 8th, i can do an electronic payment for $500 or even a bit more that day. That will leave me with little or no reported balance posted (and reported) that month.

Because I have more active credit card accounts than FICO prefers, I regularly use this strategy myself.

-FiLife Gurus Dave Hanson and Dean Binder

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