What’s The Difference Between Credit & Debit Transactions?
As consumers, we all have a good understanding of the difference between a credit card and a debit card. For a credit card, we get a statement on a monthly basis, and we can pay off the entire balance or only a portion of the balance while paying interest on the rest. In other words, credit cards work like bank loans.
If we use a debit card, however, the money is immediately taken out of our bank account, and we will not have to deal with additional statements. Debit cards are more analogous to paying by cash or by check.
For a merchant, the cost of processing a debit card transaction can vary quite a bit from that of processing a credit card. Otherwise, a merchant receives the money within the same timeframe, so that there appears to be very little difference between the two methods of payment.
That said, at times, a point-of-sale terminal will ask the customer to choose between credit or debit after they swipe, dip, or tap a debit card. Answering credit does not suddenly turn a debit card into a credit card, but it does affect the merchant’s cost of processing the transaction.
Below, we give a more detailed explanation of how credit and debit transactions can impact a merchant’s costs of doing business.
Table of Contents
Understanding How Debit Cards Work
Generally, there are two behind-the-scenes ways a debit card can be processed. The first way is called the debit/online/PIN debit method, and the second way is called the credit/offline/signature debit method. If the customer selects “credit”, the transaction is sent through the credit card processing network. If the customer selects “debit”, the transaction is sent through a different computer network and the merchant is charged a debit-specific rate for the transaction. Both methods will fund the merchant’s bank account in about the same timeframe. The difference is only in the fee that’s charged per transaction.
In order to better understand how debit cards work, let us first examine how credit cards work.
How Credit Card Transactions Work
Credit cards essentially are revolving lines of credit between the issuing bank and the consumer. When a consumer pays with a credit card, the money is transferred in roughly the following way:
- The payment information is transmitted through multiple tiers of financial entities to the acquiring bank.
- The acquiring bank asks the issuing bank for payment.
- The issuing bank, after it makes sure the consumer has enough credit, authorizes the payment.
- The acquiring bank pays the merchant.
- Typically, two to three days later, the two banks pay each other to settle the charges.
- Now the only money owed is between the consumer and the issuing bank.
- The consumer pays the issuing bank on a monthly basis, according to the terms of the credit card agreement.
For the banks, there is some risk involved in credit card transactions because the consumer might default on the loan.
How Debit Card Transactions Work
Debit cards work differently because the consumer has already pre-authorized the bank to take the money from a specific bank account. So, when the issuing bank of the debit card gets a payment request from the merchant’s bank, the issuing bank authorizes payment and then, without waiting for additional authorization, takes the money out of the consumer’s bank account.
There is very little risk of default to the issuing bank on a debit card charge because the issuing bank can make sure the bank account does indeed have the money before authorizing payment and can place a hold on that amount until, in the regular course of business, the money can be transferred out of the account. Again, the distinguishing difference between a credit card charge and a debit card charge is that, with a debit card, the issuing bank is allowed to reach into the consumer’s bank account to take the money right away.
We’ve gone over a high-level view of how a debit charge works, but if we dig a little deeper, debit card transactions can get a little complicated.
The Different Paths A Debit Card Transaction Can Take
As mentioned in the introduction of this article, a consumer might have to select debit or credit after swiping, dipping, or tapping a debit card. Typically, this question is only asked if the merchant is at a brick-and-mortar location and has a PIN pad on their point-of-sale terminal. If the merchant operates online, uses a point-of-sale terminal without a PIN pad, or uses a third-party processor such as Square, Stripe, or PayPal, then the question won’t be asked because there will be only one way to process the debit card–by using the credit method.
With the credit method, the debit card charge is processed like a credit card charge. This method is also called a signature debit or offline charge. For clarity, in this article, I will refer to this type of charge as a credit path debit charge.
If the merchant does have a point-of-sale terminal with a PIN pad, then the consumer has a choice of processing the charge as either a credit path debit charge or a true debit charge. The true debit charge is also sometimes called the PIN debit or online charge. Both the true debit charge and the credit path debit charge will be explained in more detail below.
What Happens When A Consumer Selects The Credit Path Debit Charge Option
When a consumer makes a credit path debit charge, the transaction is sent through the system like any regular credit card charge, except that it is flagged as a debit transaction. The payment request goes from the merchant to the processor to the acquirer to the issuer. The issuer — that is, the bank where the customer keeps the bank account tied to the debit card — puts a hold on that amount of money in the account and then authorizes the acquirer to release the money to the merchant.
The merchant is paid in the same way and in the same time frame as any typical credit card charge. However, from the consumer’s standpoint, there will be a hold on that amount of money in their bank account, usually for up to three business days, until the bank takes the money out.
A hold on the account means the money is still technically in the account but is earmarked to be taken out, so the consumer can no longer use that money to make other purchases. Sometimes, this hold can be larger or smaller than the actual charge. If it’s larger than the actual charge, it can cause non-sufficient funds (NSF) issues on a later charge. If it’s smaller than the actual charge, it can cause overdraft issues on a later charge.
So, with a credit path debit charge, it can take up to three days for the issuing bank to pay the acquiring bank for the money the acquiring bank already fronted to the merchant for the debit card charge. This payment timeline mainly has to do with the way credit card companies, acquirers, and issuers settle charges between themselves.
What Happens When A Consumer Selects The True Debit Charge Option
The behind-the-scenes money movement works differently with a true debit charge. Instead of borrowing the credit card company’s communications network, the true debit charge uses various other communication networks for interbank money transfers. This is the same path used by ATM networks, wire transfer networks, electronic bill payment networks, or even direct deposit paychecks.
With a true debit charge, when the debit card issuing bank gets the payment request, it places a hold for that amount of money in the consumer’s account and transfers the money through normal interbank money transfer channels to the merchant’s bank. The hold on the consumer’s account is much shorter than it would be with a credit path debit charge because banks settle these transfers much more quickly — sometimes in just a matter of hours, and typically by the end of the business day.
Because money is transferred so quickly, the true debit charge typically requires an added layer of security in the form of a PIN. The PIN is encrypted and serves as additional evidence that the debit card holder has authorized the charge.
A merchant is charged differently when running a debit card transaction as a true debit charge or as a credit path debit charge. The reason is simple: it costs money to send information through these (typically computer) networks, and each network charges a different amount.
Even though the way the banks transfer the money to one other is the only real difference between a true debit charge and a credit path debit charge, the credit path debit charge is subject to different rules (set up by the credit card companies) and is treated differently under the law. We point out the key differences below.
Key Differences Between Credit & Debit Transactions
Whether your customer uses a credit or debit card, the money shows up in your bank account relatively quickly, but there are a few discrepancies between the different types of transactions that can affect your business. Keep in mind that we are actually looking at three types of transactions: (1) a true credit charge, (2) a true debit charge, and (3) a credit path debit charge. The answer will vary slightly for each.
Merchants are charged per credit or debit transaction, and the charges depend on whether the card is processed through a credit card network or the debit card network. If a card—whether credit or debit—is processed through a credit card network, it will be charged the typical credit card transaction fee. If a debit card is processed through the debit card network, the transaction is charged a debit card rate. Some processors, in an effort to compete for your business, might offer a fee for a credit path debit charge that falls between a standard credit card charge and a true debit charge.
For debit cards backed by banks in the US, the federal government has set a standard rate for banks with $10 billion or more in assets. (See the Durbin Amendment of the Dodd-Frank Wall Street Reform and Consumer Protection Act.) Currently, that rate is 0.05% + $0.21 per transaction ($0.22 if the transaction meets certain fraud criteria). Smaller banks can charge more, and processors who contract with the large banks can add to this government-set base charge. For banks outside of the US, the processing rates can be even lower. Check your processing agreement to see the amount that is applicable to you, and remember that it might be possible to negotiate this rate.
For credit cards, if you’re a frequent reader of this website, you already know that the rate varies, so be sure to check your credit card processing agreement for the precise amount. This charge typically applies to both your true credit card transactions and your credit path debit card transactions.
As between pure debit transactions and credit path debit transactions, the math works out that smaller charges cost less if processed as credit path debit charges. Larger ticket items cost less if processed as true debit charges. We have an article giving a very detailed explanation of the true cost of debit card transactions and credit path debit card transactions. We also have multiple articles comparing credit card rates. Be sure to check them out as you consider your options.
Credit and debit card disputes are covered not only by different consumer protection laws, but they are also modified by credit company rules if the transaction is run through credit card companies. From a high level, both credit and debit card disputes will first show as a chargeback on a merchant’s statement. The merchant can respond to the chargeback (and pay appropriate fees) according to the procedure set out by the merchant’s processor.
Debit card disputes tend to show earlier in the chargeback cycle. Consumer protection laws covering stolen debit cards give the consumer a specific time frame to report a stolen card, and if the consumer reports outside of that time frame (i.e., more than 60 days after receiving a bank statement reflecting the unauthorized charge), then the consumer must pay for all the unauthorized charges, and the merchant gets to keep the money.
With credit card disputes, a different set of laws govern fraudulent charges, and the consumer is typically liable for only up to $50 of the charge. The consumer also has longer to dispute the charge, so the merchant might have to answer a dispute later into the chargeback cycle.
For a true credit card charge or a credit path debit charge, merchants can require a minimum amount a customer must charge for using a credit or debit card. Additionally, as long as a state’s laws allow it, the merchant can attach a surcharge to the use of a credit card to recover processing fees for the card. Mostly, what the merchant can and cannot do depends on the credit card company’s rules, and these rules discourage surcharges and encourage the use of the cards for transactions of any size.
With a debit card, the merchant cannot require a minimum amount nor can it add a surcharge for the use of the debit card. Debit cards are regulated by a very different set of laws than credit cards, and current laws forbid requiring a minimum charge or adding a surcharge to a true debit card transaction.
How To Accept Debit Card Payments
From a merchant’s perspective, if you can accept a credit card, then you can almost certainly accept a debit card. Naturally, you should check with your processor first, but even if you do not have a PIN pad at your point-of-sale terminal, you should be able to process a debit card using the credit path debit charge method.
If you do have a PIN pad at your point-of-sale terminal, then you have the hardware needed to accept credit card transactions, credit path debit transactions, and true debit transactions. Double-check with your processor that all three methods are allowed. If so, your customers can swipe, dip, or tap credit or debit cards as normal, and you will be charged depending on the type of card and the transaction path of the card.
As a side note, if you travel to Canada, the UK, or mainland Europe, you will see that having a PIN pad is fairly normal and both credit and debit cards can require a PIN before use.
How To Accept Debit Card Payments On A Phone
With the popularity of mobile point-of-sale devices, you might be wondering if you can accept a debit card with a phone-connected reader from, for instance, Square (read our review) or PayPal Here (read our review). These readers typically do not have PIN pads. In these cases, you can indeed accept a debit card because the transaction can be processed as a credit path debit charge.
Outside of the US, this is not the case. For example, Square can accept Interac debit transactions in Canada. iZettle (read our review) and SumUp (read our review) can also accept debit transactions in Europe.
Is The Difference Between Credit & Debit Transactions Important?
From a consumer’s standpoint, the difference between using a credit or debit card definitely matters because money is taken out of one’s bank account at very different times after using a card. The dispute process for a credit card is typically less painful than for a debit card. After all, with a debit charge, the money has already been taken out of the bank account and the consumer protection laws for debit cards place a higher burden on the consumer to be vigilant for fraudulent charges.
From a merchant’s standpoint, the difference between a credit and a debit card matters less but still can be detectable because the transactions carry different costs. In fact, because a PIN pad is necessary to initiate a true debit charge, a merchant must invest in purchasing a point-of-sale terminal with a PIN pad before a true debit charge can be processed. For larger ticket items, a true debit charge can cost the merchant less to process than a credit charge or a credit path debit charge.
At the end of the day, a merchant typically wants a customer to have a smooth purchasing experience, which includes an easy checkout when paying for the purchase. This often translates to being able to accept any form of payment that is convenient to the customer. So, while there is a difference in the cost of processing debit and credit cards, this cost is likely minor when compared with keeping a customer satisfied so they come back to your store for more.