Why Using Debit Cards Can Be Dangerous

Americans pull out their debit cards for purchases almost as frequently as they take out cash, but hidden fees and security issues could outweigh the convenience.

In 1995, 60 percent of people used cash for purchases, while only 2 percent used debit cards (or check cards) and 8 percent used credit cards, according to a study on consumer preferences by Dove Consulting. By 2003, though, this balance changed significantly, Dove found, with 32 percent using cash, 31 percent using debit cards and 21 percent pulling out credit cards for purchases.

In fact, according to Cardweb.com, more than 52 million purchase transactions on credit and debit cards pass through the Visa and MasterCard networks every day in the United States.

As the use of debit card increases, it is essential for consumers to be on the lookout for their hidden fees and possible security pitfalls. Here are some common questions.

1. Are there different types of debit cards? Debit cards come in two different flavors, deferred and direct. A deferred — or signature-based — debit card is similar to a credit card without the credit. You sign for your purchases and the money is debited from your checking account within two to three days. A direct — or PIN-based — debit card requires you to provide a PIN, or personal identification number, to authorize your purchase and the money is withdrawn from your account immediately. According to Cardweb.com, in 2002, Americans made $180 billion in purchases on debit cards that required using a PIN and $318 billion on those that did not.

2. If given the choice, is it better to use a direct or deferred debit card? Similar to ATM surcharges, direct debit card purchases may come with charges that will show up on your bank statement. Hidden fees, the result of the battle between retailers on one side and banks and credit card issuers on the other, can add up significantly. As a result, to reduce their expenses, many stores encourage PIN-based transactions and some stores no longer accept debit card purchases that require signatures.

When using your PIN to make a purchase, the retailer usually pays a flat fee to the bank, which averages at about 20 cents per purchase. However, if you choose to use your debit card as a credit card, which requires a signature, the retailer generally has to pay a percentage fee based on the amount of your purchase, which can be as high as 2.5 percent. As a result, to reduce their expenses, many stores encourage PIN-based transactions and some stores, such as Wal-Mart, no longer accept debit card purchases that require signatures.

This tactic results in $3.5 billion in lost processing fees for banks. To recoup this revenue, some banks have started to charge consumers a fee, generally between 25 cents and $1.50, for every PIN-based purchase. These fees are subtracted from your checking account along with your purchase.

In New York, for example, a survey by the New York Public Interest Research Group found that 47 percent of 31 New York banks surveyed charged a debit card fee at the point of sale without warning the consumer.

Mellody's Tip: Check your bank statement every month to determine if you are being assessed fees for your debit card transactions. If your bank is charging you, be sure to select the "credit card" option when making purchases with your debit card to avoid entering a PIN and the associated fees.

3. What kind of protection do you have if your debit card is lost or stolen? Debit cards do not afford the same piece of mind when it comes to financial security as credit cards. The major difference concerns the federal regulations regarding your fraud liability. For credit card users, there is usually a $50 liability cap, meaning you are responsible for the first $50 in damages. For example, MasterCard limits a customer's liability for losses incurred from a lost or stolen MasterMoney card to $50. However, the liability could be as high as $500 on some bank debit cards and could often include a lengthy and cumbersome back and forth between you and the bank. In addition, unlike a credit card, if you are dissatisfied with the purchase, you are not able to withhold payment until further investigation by the credit card company. Simply stated: There is no Fair Credit Billing Act for debit cardholders. Instead, you are on your own to resolve a dispute with a vendor when you debit your purchase.

Mellody's Tip: When it comes to making major purchases or shopping online, use your credit card instead of a debit card. Also, time is essential when it comes to reporting a lost or stolen card, so call your bank immediately. Visa debit card customers pay nothing if the card is reported missing within two business days.

4. Will using a debit card prevent you from over drafting on your account? No, some debit cards actually allow users to overdraw, or spend more than they have in their checking accounts. If you use a deferred debit card and simply sign for your purchases, many banks will let you exceed the checking account balance and possibly hit you with an overdraft fee. This fee is usually around $30.

Mellody's Tip: Balance your debit card as you would your checkbook. It is very important to maintain the receipts from all of your purchases to ensure no additional money is being erroneously debited from your account. 5. Does your employer offer a payroll card? In addition to traditional uses, debit cards are being put to work in even more creative ways such as payroll processing.

Launched in the late 1990s, the payroll card allows employers to debit an employee's paycheck to a special account providing the employee with immediate access to his or her money, which can be withdrawn at ATMs or used for purchases like any other debit card. Although these cards do not offer check-writing abilities, they are especially beneficial to the 14 million households without bank accounts and are growing more and more popular. In fact, the number of payroll cards has doubled in the past year to 2.2 million, according to market research firm Financial Insights, with well-known companies such as Sears, UPS, U-Haul, Coca-Cola and Dominos using them.

For employers, these cards offer significant savings. The cost of issuing a paper check ranges from $1 to $2, while the cost of an electronic transaction through direct deposit or a payroll card is only about 20 cents.

While the cost savings are significant for the employer, employees are subject to some additional fees with a payroll card. Some financial institutions issuing payroll cards charge monthly maintenance fees, which can range from $1.50 to $8, but these fees are often waived for the first year. Employees may also be assessed usage fees for each ATM transaction as well as a small fee — 25 cents to 50 cents — for each purchase used with a payroll card. Although these fees add up, people without bank accounts spend an estimated $30 a month to cash their checks and get money orders.

Mellody's Tip: If your employer offers debit payroll processing, be sure you understand the fees. In some cases, you may be better served opening a checking account and having your paycheck directly deposited. 6. What is a medical benefits debit card?

Some companies are also issuing medical benefits debit cards, which allow employees to make purchases with money set aside in a flexible spending account, or FSA. FSAs permit employees to contribute pre-tax dollars to an account established specifically to pay for medical expenses. Covered expenses include eyeglasses, birth control, dental work (not including cosmetic), co-payments for prescription drugs and doctor's visits, as well as many over-the-counter medicines, such as antacids, allergy medicine, cold medicine and pain relievers. The benefit of having your flexible spending dollars on a debit card is that your transactions are easily organized.

For those individuals who itemize their tax returns, this is especially useful as you can access a record of your annual purchases electronically. In order to ensure employees are using the medical debit cards appropriately, they are required to certify that the card will only be used for eligible health-care expenses and that the expenses have not already been reimbursed by another source.

Currently, 800,000 workers have medical debit cards, up from 60,000 three years ago, according to MBI, a leading provider of medical benefits cards. This number will likely grow with the creation of health spending accounts, or HSAs, in the recent Medicare legislation. HSAs permit employees to roll over money set aside for health care that is not used by year's end into interest-bearing IRAs. Alternatively, the money can also be carried over to cover medical expenses in the following year.

Mellody's Tip: If your employer does offer a medical benefits debit card, take advantage of this benefit. It will make your record keeping easier encouraging you to take advantage of the FSAs. 7. If you do not have a checking account, can you still have a debit card?

Partnering with UniRush Financial Services, hip-hop mogul Russell Simmons launched the Rush Visa Card in early 2003 to provide access to a prepaid debit/credit card to those without banking accounts or poor credit histories.

The Rush Visa Card can be funded through one of five ways: tax refunds, payroll direct deposit, MoneyGram, money orders or ACH bank load. To sign up for this card, you need to provide your Social Security number and a valid address, and pay a $19.95 sign-up fee. You can then use the Rush Visa Card to make purchases and pay bills. When making purchases, you are assessed a $1 fee per transaction. When using your Rush Visa Card to send checks for your rent or other bills, you are assessed a fee of $1.95 per check. Aside from the sign-up fee and transaction fees, there are no other fees associated with this card.

8. So, should you go debit or credit when it comes to your purchases? In most cases, choose debit over credit. As long as you carefully monitor your purchases and closely check your bank statement for fees, a debit card should be your go-to for everyday purchases. Using a debit card can prevent you from spending money you do not have and will save you from the dreaded high annual percentage rates of credit cards.