Explanation of Debit & Credit

For years, when it came to purchasing different items, you could choose cash, check or credit. In the early 1990s an alternative form of payment started to gain in popularity, the direct debit, which could be also be accomplished using a card. Together, credit and debit have revolutionized the retail world and created a great deal of convenience for consumers.

Identification

Although the terms debit and credit may sound like they are related, they are actually two very different concepts. A debit is a deduction taken out of an account holder's account and moved to different location. Merchants may do this through a check, debit card or electronic transfer. Credit generally refers to the ability to buy something by taking out a loan, such as with a credit card.

Credit Card History

The first credit cards were store-based cards mainly designed to increase customer loyalty for certain stores or brands. In 1946, the first bank card was issued, known as Charg-It. While plastic cards have become a standard, the first cards were made of cardboard. Revolving lines of credit began in 1959. The two major credit card associations were formed in 1966. Bank of America started the card that would eventually come to be known as Visa, and another group of banks came together to form what would come to be called MasterCard.

Debit Card History

Debit cards, while they take advantage of the some of the same technologies as credit cards, came onto the scene a couple of decades later. Though they were available in the 1980s, the format really began to gain popularity in the 1990s. As terminals that could read the cards grew and more banks began offering the option as a standard instead of an ATM card, the volume of sales grew. In 2009, debit cards outpaced credit card transactions, accounting for $1.63 trillion in sales.

How They Work

Debit cards and credit cards function very much the same way. The magnetic strip on the back of a card operates as a hard drive, where data such as the user's account and routing numbers are located. When that strip is read, or the number entered into the machine, the information is transferred onto the network, eventually leading to a debit from the user's account and a credit to the merchant's account.

Consumer Differences

The major difference for the consumer is in how payment is handled. Consumers using credit transactions have the purchase amount added to a balance, which must be paid back over time. Debit transactions, on the other hand, directly take the money out of a personal banking account, such as a checking account, or in some cases, a savings account.

Merchant Differences

The main difference for the merchant is the fee that is charged for a credit or debit card transaction. Banks may charge merchants as much as 3 percent for a credit card transaction but only half that amount for a debit card transaction since there is less risk to the merchant.